Dividends Vs Salary

In light of the 2016/7 dividend tax changes, business owners are to reconsider the detail of their dividend v salary choices. If we look at the situation where the income in question falls above the upper earnings limit/higher rate threshold, the advantage of dividends remains, but is reduced (as the Chancellor intended):

                                                                    Salary                       Dividend
Gross profit                                       £1,000.00                       £1,000.00
Corporation tax @ 20%                             N/A                        (£200.00)
Dividend payable                                        N/A                          £800.00
Employer’ NIC @ 13.8%                    (£121.27)                                N/A
Salary                                                      £878.73                                 N/A
Employer’ NIC @ 2.0%                       (£17.57)                                 N/A
Pre-tax amount                                     £861.16                         £800.00
Net to 40%/32.5% taxpayer               £509.67                          £540.00
Net to 45%/38.1% taxpayer               £465.73                          £495.20

However, remember that to reach this stage, at least £4,193 of employee NICs will have been paid.

The abolition of the 10% tax credit gives dividends another advantage over salary/bonus in that gross income is kept down as the table shows:However, remember that to reach this stage, at least £4,193 of employee National Insurance Contributions (NICs) will have been paid.

Gross income and gross profit cost to produce £1,000 net of tax and employee NIC income

Tax rate + NIC                           Salary                                    Dividend
Salary/Dividend                Income   Profit Cost           Income     Profit Cost 
(above allowance)                 £                 £                          £                £
20%+12%/7.5%                1,470.59    1,673.42            1,081.08     1,351.35
40%+2%/32.5%                1,724.14    1,962.07            1,481.48     1,851.85
45%+2%/38.1%                1,886.79    2,147.17            1,615.51     2,019.39

The smaller gross equivalent achieved by paying dividends is of increased importance when the (unindexed) thresholds for child benefit tax, phasing out of personal allowance, tapered annual allowance, etc are considered. Also significant is that the gross profits cost of the dividend route is less than the salary alternative for each tax rate.

As a general rule, dividend payments are directly proportionate to shareholdings, which means the dividend or salary choice can become impossible to make when there is a mix of shareholdings and total remuneration targets.

Dividend payments rather than salary may have adverse effects where tests are generally salary-related, eg mortgage borrowing capacity. However, the issue of lost S2P no longer arises in the world of the single-tier state pension.

When considering the alternative of a pension contribution, of course, this is only feasible if the individual does not need the money for expenditure. If this test is passed, then the next question is whether a contribution with full tax relief is possible in the light of the tapered annual allowance, reduced lifetime allowance and any transitional protections in place. If none of these are a constraint, then the pension contribution is a completely tax-free exercise at the point of employer payment of the contribution.

The simplest way to consider the end value is to ignore any investment return and assume a full pension is drawn, ie 75% of the contribution attracts (retirement) marginal rate tax and the other 25% is tax free. Thus, for example, a higher rate taxpayer receives a net £700 (.75 x £1,000 x .6 + .25 x £1,000) per £1,000 of contribution. The corresponding figures for basic and additional rates are £850 and £662.50.

Comparing numbers at this stage starts to get complicated because of the dividend allowance and assumptions about how any dividend drawn would be invested (remember there is a £20,000 ISA limit from 2017/18). For a basic rate taxpayer, there is only limited advantage (via the 25% tax-free element) until the dividend allowance is exhausted. Higher and additional rate taxpayers will see more benefit, particularly if their marginal rate falls in retirement.

For those aged 55 and over, there is another avenue to consider in terms of drawing pension benefits rather than dividend/salary as a source of income and making employer pension contributions to ‘compensate’ the pension fund for the drawn benefits.

Contact us for more information on how Lexington have help you with you Financial Planning and Wealth Management contact us on 01793 7710963 now.

 
 
 

Lexington Wealth Management