For business owners, it can be a balancing act to find the most tax-efficient way to get paid from the company’s profits.
In the UK, a company director can choose to take their earnings as a dividend or as a salary. But both have different tax implications, so it is important to understand the difference between the two before making a decision.
What is a dividend?
A dividend is a distribution of a company’s profits to its shareholders. Dividends are typically paid out quarterly (but this can almost any time period), and the amount each shareholder receives is based on the number of shares they own. Dividends are taxed at the shareholder’s marginal rate, which is the rate of tax they pay on their last pound of income.
What is the UK Tax on dividends?
Every taxpayer in the UK has an allowance of £2,000 which is tax free. This has been the rate for a number of years and is correct for the 2022/23 year. Before this (back in 2017/18) it was a more generous £5,000. Any income from dividends over this £2,000 will be taxed at the marginal rate, which is as follows:
- Basic rate: 8.75%
- Higher rate: 33.75%
- Additional rate: 39.35%
Don’t forget though, that this is ALL dividend income you receive. So if you’ve got a General Investment Account (stocks and shares that aren’t wrapped in an ISA) any dividend income from this will also add to this limit.
What is a director’s salary?
A salary, on the other hand, is a regular payment that a company makes to an employee for their work. Salaries are taxed at the employee’s marginal rate, which is the rate of tax they pay on their first pound of income. The amount of tax an employee pays on their salary will depend on how much they earn. As a director is potentially also an employee,
Disadvantages of paying a directors salary
One of the drawbacks of a means that you must pay National Insurance Contributions from both yourself and the company. And, due to the new health and social care reforms, as of April this year (2022) both of these have been increased by 1.25 percentage points.
So, which is best – salary or dividends?
The answer, as always, is that it depends on your circumstances and what’s best for you. Having said that, many business owners pay themselves a regular salary, along with dividends too. This maximises their tax allowances for each threshold.
Other ways to extract profit from your Limited company
There are a few other ways you can provide some extract. The main one being a company director pension scheme. This is because the pension payments from the company can be classed as a business expense. This has the added benefit of offsetting corporation tax for the company, and the company director doesn’t pay any tax until they draw down the pension at retirement – at which point it may be just the basic rate of tax, depending on how the pension is drawn down.
