The following article is an excerpt taken from the new guide '101 Business Tax Tips' 2022/23 edition. Save 30% Today.
One of the perceived major benefits of incorporation is the ability to extract profits from the company by way of dividends. The main advantage is the National Insurance saving, as no NICs are payable on dividends, whereas a salary payment would attract employee NICs of 13.25% or 3.25% and employer NICs of 15.05% (2022/23 figures) once the salary exceeds the primary and secondary thresholds.
In determining the optimal salary level for 2022/23, it is necessary to take account of the availability of the NIC employment allowance (for which see Tips 71 and 72).
All taxpayers receive a dividend ‘allowance’, regardless of their marginal rate of tax. This dividend allowance is set at £2,000 for 2022/23. However, this is not an ‘allowance’ as such, rather a zero-rate band which taxes the first £2,000 of taxable dividend income at a rate of 0%.
Thereafter, for 2022/23 dividends (which are treated as the top slice of taxable income) are taxed at 8.75% to the extent that they fall within the basic rate band, 33.75% to the extent that they fall with the higher rate band, and 39.35% to the extent that they fall within the additional rate band. The dividend tax rates are increased by 1.25 percentage points from 6 April 2022 to provide funding for health and adult social care.
A payment of salary will attract tax at the taxpayer’s marginal rate of income tax (20%, 40% or 45% (or, for Scottish taxpayers, at the relevant Scottish rate)). Salary payments are deductible in calculating profit for corporation tax purposes, unlike dividends which must be paid out of after-tax profits. Further, a dividend can only be paid if there are sufficient retained profits. In addition, various company law requirements must be met.
It is not simply a case that dividends are always best, although in many cases, taking dividends will result in less tax and National Insurance than taking a salary payment.
However, the best result will depend on the circumstances, as the decision whether to take salary or dividends will depend on the interaction of various factors – respective rates of income tax, corporation tax and National Insurance contributions, any other income that the taxpayer has and whether the company has sufficient retained profits.
To decide whether to extract profits by way of a dividend or a salary, crunch the numbers first. (The rates applying for 2022/23 and the financial year 2022 are used in the example.)
Looking ahead: the rates of corporation tax will increase from 1 April 2023 for companies with profits in excess of the lower limit, set at £50,000, as divided by the number of associated companies plus 1. From this date, where profits exceed this level, corporation tax will be charged at 25%.
However, this will be reduced by marginal relief where profits fall between the lower limit and the upper limit, set at £250,000 as divided by the number of associated companies plus 1. The rate at which corporation tax is payable will impact on the profit extraction salary.
Remuneration Or Dividend?
Paul is the director of a small company. He has profits of £20,000 (before corporation tax) and wants to know whether to extract them by way of a salary or a dividend. It is assumed that he has already received a small salary equal to his personal allowance.
He has a small number of employees and has utilised the NIC employment allowance in respect of employer’s NIC payable in respect of earnings paid to his employees.
Less Employer’s NIC @15.05% (£2,616)
Available to pay as salary £17,384
Less Income Tax @ 20% (£3,477)
Less NIC @ 13.25% (£2,303)
Retained by shareholder £11,604
There is no corporation tax to pay as taxable profits are reduced to nil after deducting salary of £17,384 and employer’s NIC on that salary of £2,616.
Less Corporation Tax @ 19% (£3,800)
Distributed as a dividend £16,200
Income Tax (£1,242)
Retained by shareholder £14,958
The whole dividend falls within the basic rate band (£37,700 for 2022/23). The first £2,000 of the dividend is taxed at 0% and the remaining £14,200 is taxed at 8.75%. The total tax payable on the dividend is therefore £1,242 ((£2,000 @ 0%) + (£14,200 @ 8.75%)).
In this situation, Paul is better off by paying a dividend as he is able to retain £14,958 of the profits, as compared to retaining only £11,604 if they are extracted by way of a salary payment.