As the director wishing to take money out of the company, popularly you have two options : salary or dividends.
However, the best answer is not fairly straightforward and the approach is tailored to the context of the individual. Additionally, there may be legal and regulatory considerations to take into account. So what is the best course of action?
Balancing Financial Goals with Long-Term Tax Planning
The corporation tax of 19% (25% for companies over £250,000 in profit from April 2023) is more favourable and tax efficient than paying tax at the rate of 40% for income to an individual whose income is over £50,270 and 45% if it is over £150,000 (£125,140 from April 2023).
Hence investing in a Limited company can be tempting to many.
As every rose has its thorn, the lower tax rate is beneficial only if you wish to keep the money in the company. A major issue arises when you wish to take money out of the company.
We are going to look in detail at each option to determine what is more tax- beneficial to you.
How Directors are Taxed : Employment Income
Employment income generally means Salary and bonuses.
Employment income is subject to Income tax and National Insurance contribution. However, these expenses are tax deductible in the hands of the company.
The Income tax rate on the directors’ salary is:
|
Tax Rate |
Taxable Income |
Taxable Income(2023/24) |
|---|---|---|
|
0% |
First £12,570 |
First £12,570 |
|
20% |
£12,571 to £50,270 |
£12,571 to £50,270 |
|
40% |
£50,271 to £150,000 |
£50,271 to £125,140 |
|
45% |
Above £150,000 |
Above £125,140 |
For example,
Paul earns £60,000 annual salary as the director of company. What will be his income tax?
|
Tax |
Taxable Income |
Income Tax |
|---|---|---|
|
0% |
First £12,570 |
£0 |
|
20% |
£12,571 to £50,270 |
£7,540 |
|
40% |
£50,271 to £60,000 |
£3,892 |
|
Total |
£11,434 |
In addition to the income tax, national insurance contribution is required by both Company and from the director’s salary on the level of the salary income paid.
The contribution from the Director’s salary is Primary Class 1 National Insurance Contribution. Whereas, the contribution by the company is Secondary Class 1 National Insurance Contribution.
For the directors’ salary income, the national insurance contribution (Class 1) is as follows:
|
Class 1 Limit |
Annual Salary (2022/23) |
Annual Salary 2021/22 |
|---|---|---|
|
Primary Threshold |
£11,908 |
£9,568 |
|
Secondary Threshold |
£9,100 |
£8,840 |
The mini-budget reversed the of the rise of the National Insurance Contribution by 1.25%.
The detail of the National Insurance contributions rate has been given below:
|
Pre-mini budget (applicable from 6 April 2022 to 5 November 2022) |
Post-mini-budget (applicable from 6 November 2022) | ||
|---|---|---|---|
|
Employee |
Employer |
Employee |
Employer |
|
Salary upto £50,270 at 13.25% |
Salary above £9,100 at 15.05% |
Salary upto £50,270 at 12% |
Salary above £9,100 at 13.8% |
|
Salary above £50,270 @ 3.25% | Cell |
Salary above £50,270 at 2% | Cell |
For example,
Continuing with the above example, his national insurance contribution during 2022/23 would be as follows:
|
Tax |
Limits |
Primary Contribution |
|---|---|---|
|
0% |
On the first £11,908 |
£0 |
|
12% |
On the next £38,362 |
£4,603 |
|
2% |
On the final £9,730 |
£195 |
| Cell |
Total |
£4,798 |
Assuming that the company utilised the Employment allowance of £5,000 (£4,000 during 2021/22) during the year, his company’s national insurance bill on his salary will be:
|
Tax |
Limits |
Secondary Contribution |
|---|---|---|
|
0% |
On the first £9,100 |
£0 |
|
13.8% |
On the next £50,900 |
£7,024 |
| Cell |
Total |
£7,024 |
The company’s national insurance bill is £7,024, but since the contribution is tax-deductible, the company’s national insurance bill on his salary net of corporation tax is £5,689.
To summarise both illustrations:
|
Product Name |
Price |
|---|---|
|
Income tax |
£11,434 |
|
Director’s National Insurance contribution |
£4,798 |
|
Company’s National Insurance contribution |
£5,689 |
|
Total Tax | |
|
£ 1,000 | |
So, What is Optimal Salary?
Let’s look at this with an example assuming that the company does not have a spare employment allowance:
For example,
Sam has paid a salary of £9,100 during 2022/23. As this is within the secondary threshold limit, the company is not required to make any National Insurance contribution.
The corporation tax relief on the payment is £1,729.
However, increasing the salary of £9,100 up to £11,908, it will result in small employer’s national insurance contribution. Still, as the extra salary and employer’s national insurance is tax-deductible, it will outweigh the national insurance cost.
When salary is £11,908, the employer’s national insurance contribution will be:
- £2,808 x 13.8% = £388
The corporation tax relief on increased salary will be:
- £2,808 x 19% = £534
- £388 x 19% = £74
So, the extra corporation tax relief of £608 outweighs the national insurance cost of £388.
Paying salary above £11,908 is an unattractive option as both employer and Employee National Insurance contribution has to be made in excess of the Primary and Secondary threshold limit.
But what if there is a spare employment allowance?
In that case, the salary to the director of £12,570 is more tax beneficial.
Let’s understand this with an example:
For example,
Instead of being paid £9,100, Sam is paid £12,570. If Sam takes £12,570, an additional National insurance bill of £80 arise from him personally. The secondary National insurance is covered by the spare employment allowance.
However, the additional salary of £3,470 is tax deductible and corporation tax relief of £659 is available to the company.
The chart below gives the summary of the optimal salary from the point of view of company:
How Directors are Taxed: Dividend Income
Paying Dividend is the most popular option for taking the money out of the company. Unlike salary, Dividend payment avoids paying any National Insurance contribution by both Company and the Director.
For Dividend earned in 2022/23, the dividend allowance is £2,000. The Dividend allowance will be reduced from £2,000 to £1,000 from April 2023 and then to £500 from April 2024.
| Header |
2022/23 |
2023/24 |
2024/25 |
|---|---|---|---|
|
Dividend Allowance |
£2,000 |
£1,000 |
£500 |
For dividend received in excess of the allowance, the tax rate is as follows :
|
Taxable Dividends |
Rate (2021/22) |
Rate (2022/23) |
|---|---|---|
|
Dividends taxable at Basic Rate |
7.5% |
8.75% |
|
Dividends taxable at higher Rate |
32.5% |
33.75% |
|
Dividends taxable at additional rate |
38.1% |
39.35% |
For example,
Samantha is the director of the company with Salary of £11,908 during 2022/23. She received a cash dividend of £20,000 during the year, making the total income from her business of £31,908.
Her Salary is tax-free (assuming the company has no spare Employment allowance) as it is under the Personal allowance.
The difference between the Personal allowance and the salary will be tax-free. Along with the Dividend allowance of £2,000, her total tax-free dividend would be £2,662.
The remaining dividend amount of £17,338 would be taxed at 8.75%. So, the total tax would now be £ 1,517.
All taxpayers, regardless of the level of income is entitled to Dividend allowance.
And as illustrated above, if there is any unutilised Personal Allowance, there will be further tax-free allowance.
When paying the Dividend, there is no national insurance contribution on dividend income which usually makes it more attractive way of taking the money out of the company than taking the salary.
Furthermore, the income tax burden on a salary is greater than that on a dividend.
Overall Tax on Dividend-From Company and Director’s Point of View
Once the salary up to the optimum level as discussed above has been paid, it is more beneficial for the director to receive anything above that amount as dividend.
Since dividend is paid out of the post-tax profit, any dividend paid will be taxed twice- Once at 19% as corporation tax (between 19% and 25% from 1 April 2023) and next at the dividend rate in the hands of the directors.
So effectively, the total tax for 2022/23 and onwards would be:
|
Taxpayer |
Total tax (at 19% Corporation tax) |
Total tax (at 25% Corporation tax) |
|---|---|---|
|
Basic rate taxpayer |
26.08% |
31.56% |
|
Higher rate taxpayer |
46.34% |
50.31% |
|
Additional rate taxpayer |
50.31% |
54.51% |
To explain the above table better let’s look at the example
For example,
A company with a profit of £100 is taxed at 19% as corporation tax which will be £19. The profit after tax for the company will now be £81 which the company distributes as a dividend.
Assuming the director has utilised the Dividend allowance and the director is higher rate taxpayer, on the dividend of £81, the director will have to pay tax of £27.34 at 33.75%, so the total tax paid on the profit of £100 is £46.34
The reason for the total tax on dividend being higher than other conventional tax rates (20%, 40% and 45%) is to make fair treatment to the directors who wants to take salary instead of being paid dividend.
When is it preferrable to take a Salary or Dividends?
Comparatively, Dividend is more popular option than Salary. However, there are some instances where Salary will be preferred.
To summarise this:
Preferrable to take Salary
It may be tax beneficial for a director to receive a salary if they are earning less than the personal allowance and do not have significant other sources of income. In this case, the salary would be taxed at the director’s marginal tax rate, which could be lower than the tax rate applied to dividends.
Preferrable to take Dividend
If the director has a high level of income from other sources, it may be more tax efficient for them to receive dividends instead of salary, as the tax rate on dividends is generally higher than the marginal tax rate. Tax treatment of dividends varies based on individual income and amount received.
In conclusion, deciding whether to pay yourself a salary or dividends as a director of a limited company is a complex decision that depends on a variety of factors. By seeking professional advice and considering your personal financial situation, goals, and tax implications, you can make an informed decision that is most tax-efficient and beneficial to you.
Whether you opt for a salary, dividend, or a combination of both, understanding the tax implications and planning ahead can help you maximize your take-home pay and achieve your financial goals.
Do you have more queries?
We, at UK Property Accountants have been advicing our clients about efficiently saving tax. With the assistance of our expert tax advisors, you will be well-informed and equipped to make sound financial decisions. If you have any queries on tax enquiries or need some advice from us.
