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Dividend or Bonus?

Working shareholders want to extract the profits from their company in the most tax efficient manner. Typically this will be a decision between paying a higher salary/bonus or voting a dividend.

For several years there have been two headline rates of tax for companies – 19% “small companies rate” for profits below £300,000 and a 30% full rate for profits over £1,500,000 (these thresholds are divided by the number of companies which are associated with one another by reason of common ownership).

Where profits fall between the lower and upper thresholds there is a “marginal relief” that gives a smoothing effect between the small company rate and the full rate – generally the effect of this marginal relief is to tax the profits falling in this range at 32.75%.
Until now, the decision to pay a salary or dividend has been as follows:-

 

Profits Shareholder is a Higher-rate taxpayer Shareholder is a Basic-rate taxpayer

profits taxable at 19%

 

Dividend Dividend

profits taxable at 32.75%

 

Salary/Bonus Dividend
profits taxable at 30% Dividend Dividend

 
Changes in the rates of corporation tax were announced in the Budget in March 2007. The full rate will be reduced to 28% in 2009, and the small company rate will be increased gradually until it reaches 22% in 2010. The rates, including the marginal rate, in the next four years will therefore be:-

Year starting 1 April

2007 2008 2009   2010  
Small Companies Rate 19% 20% 21% 22%
Full rate of corporation tax 30% 30% 28% 28%
Marginal rate 32.75% 30% 28.75 29.50%

What is the impact of these new rates on the dividend versus salary question? ¬The simple answer is that from 2009 onwards, when the marginal rate falls below 30%, dividends will be most tax efficient in all cases. This seems to go against the concerns of the Chancellor that too many people are using companies to avoid tax, particularly National Insurance. However, the opportunity is still there, at least for now.

This analysis does, of course, ignore numerous other factors which might be relevant, such as whether it is appropriate to pay the same dividend to other shareholders who are not active in the business.

 

 

Date: 18th June, 2007
Author: Rachel Haddow

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