Being a director/shareholder offers the luxury of designing your own remuneration structure to best suit your finances and minimise your tax bill.
In recent years, this has been a fairly straightforward decision: the optimal approach (ignoring interest or rent, where available) was broadly to take a salary at, or just above, the Secondary Threshold for National Insurance (currently £9,100 a year) and the rest as dividends. That salary was enough to accrue further State pension entitlement without actually paying National Insurance, and the total tax paid from start to finish on additional earnings was almost always lower on dividends than salary/bonuses. It didn’t make much difference how small or large your income or profits, the answer was the same.
Then came the Finance Act 2021 and, with it, the increase in Corporation Tax (both in amount and complexity). This has moved remuneration planning from something of a ‘one size fits all’ solution to yet another ‘it depends…’
The optimal bonus vs dividend solution now depends on both your personal taxpayer status and the profitability of the company and, unlike recent years, there will be some scenarios in which you would pay less tax using the salary/bonus route.
As a rough guide, if company profits are below £50,000 (meaning you still pay Corporation Tax at the 19% rate), dividends remain your best option for extra income.
Or, if you are a Basic Rate taxpayer (i.e. you pay Income Tax at 20%) and will remain so even after the additional remuneration, dividends are still your preference.
However, if you pay Higher or Additional Rate tax and the company suffers a Corporation Tax rate higher than 19%, you may benefit from taking bonuses over dividends from April onwards.
This is summarised in the following table:
Please note, this ‘rough guide’ only addresses income above your various allowances. You should seek your accountant’s advice to ascertain the optimal approach given your own position.
If you are in the fortunate position whereby your company has funded all your needs and has surplus cash, there is another way of extracting profit which still scores highly for tax efficiency: pension contributions.
Money paid into your pension direct from your company should be deductible from profit, meaning no Corporation Tax to pay on the contribution; similarly, there is no Income Tax, National Insurance or any other type of tax payable on the contribution.
The money in the pension grows tax free and, if you die before withdrawing it, it should also avoid Inheritance Tax (IHT). When the time does come for you to withdraw the money, up to 25% can be received tax free with the remainder taxed as marginal income. Moreover, there will be no National Insurance to worry about (unlike any salary or bonus you receive prior to State Pension Age) and most earn less in retirement, meaning lower tax rates may apply.
Article by Lewis Pollexfen CFP