By Mark Handscombe, partner of accounts and business advisory services at Azets.

Choosing between a salary and dividends for company owners and directors has long been a matter of weighing cost-effectiveness and flexibility.

Dividends have traditionally been favoured over bonuses or salaries due to their advantages, but recent changes in tax regulations have narrowed the gap between the two options.

With the recent increase in Corporation Tax from a flat rate of 19% to an upper rate of 25%, it is no longer safe to assume that dividends are the most effective route for remunerating owners and directors. This article highlights the importance of assessing remuneration plans in light of these changes.

Entrepreneurs, business owners, and directors often engage in regular planning to extract profits from their businesses in a tax-efficient manner. While various methods can be employed, the most common options are dividends and standard salary/bonus schemes. In many cases, a combination of both approaches is utilized, depending on the personal and business circumstances of the director or shareholder.

Dividends are paid out of company profits after tax, provided the company earns enough profit to cover the dividends. One advantage of dividends is that they are not subject to National Insurance Contributions (NICs), making them an attractive method of extracting money compared to salaries. However, dividends do not reduce a company's Corporation Tax liability. The tax on dividends is determined by the individual's income tax rate, with basic rates at 8.75%, higher rates at 33.75%, and additional rates at 39.35%. Dividend taxes for the 2023/24 period would be payable through self-assessment on January 31, 2025, unless payments on account are required on January 31, 2024, and July 31, 2024.

On the other hand, receiving pay through bonuses or salaries can offer additional benefits. Individuals can accumulate qualifying years towards their state pension and make higher pension contributions if desired. From a business perspective, receiving pay through salaries or bonuses can reduce the amount of Corporation Tax paid by the company. However, unlike dividends, both the individual and the company are subject to NICs, and the individual faces a higher income tax rate. The business can claim Corporation Tax relief on the NICs and bonuses/salaries paid, deducting them when calculating profits subject to Corporation Tax.

In the past, many directors and shareholders opted for a minimal salary (up to the general NICs threshold) and relied on dividends for the majority of their income. However, recent tax rate changes have made this approach more complex, requiring additional calculations, diligence, and specialist advice.

The choice between salaries and dividends ultimately depends on the unique circumstances of each individual and their business. Moreover, the following tax changes in the new tax year further influence the decision-making process:

• Corporation Tax: Increased from a flat 19% rate to 19% on taxable profits up to £50,000 and 25% for taxable profits over £250,000.

• Marginal Corporation Tax rate: An effective rate of 26.5% applies to taxable profits falling between £50,000 and £250,000.

• Income Tax:

o Tax-free Dividend Allowance reduced by 50% to £1,000.

o Additional (45%/47%) Rate threshold lowered from £150,000 to £125,140.

o Personal Allowances frozen.

Other factors that can impact the effectiveness of remuneration plans include age (exemption from National Insurance for those over 65), pension contributions, salary sacrifice arrangements, and benefits in kind. It is crucial to review remuneration plans to ensure they align with individual circumstances, especially given the increasing complexity of the tax system and the effective rise in tax rates.

If you have questions regarding the best option for your situation or wish to discuss tax-efficient remuneration planning, our specialist team and Azets advisors are available to assist you.

Contact Mark Handscombe at mark.handscombe@azets.co.uk