Company Bonus or Dividend? (Limited Companies Only) In many small companies, the owners are also the directors, and this gives considerable scope for deciding how profits should be taken out of the company. Traditionally, small companies pay salaries to the directors and tend to ignore their second role as shareholders, which entitles them to receive dividends. Where profits are retained within a company, the situation is governed by the corporation tax rules, but when you draw profit out, income tax rules take over, and national insurance rears its ugly head. The main considerations for choosing between salary and dividends are: Corporation tax This is charged on the profits of the business after taking into account all salaries. Paying a salary reduces profits and hence reduces the corporation tax bill. A dividend payment does not reduce the taxable profit. Income tax As mentioned above, income tax is chargeable on all profits withdrawn from a company. On salary, it is collected through the PAYE system. A dividend carries with it a 10% tax credit, and for a basic rate taxpayer there is no further tax to be paid. A higher rate taxpayer will have to pay additional income tax equivalent to 25% of the dividend paid. This increases to 36.1% for those with taxable income over £150,000. National insurance contributions National insurance contributions are payable on salaries, but not on dividends. There are two elements - employee contributions and employer contributions. Employees pay 12% (2013-14) on earnings between the employee earnings threshold and the upper earnings limit, and 2% on earnings above this without any upper limit. Employers pay 13.8% (2013-14) on all salaries above £7,696 p.a. without any upper limit. Company law Salaries can be paid even when a company is making a loss. Dividends can be paid only out of profits for the year, or any undistributed profits from previous years. Other shareholders Salaries can be allocated to different directors at any rate. A shareholder is entitled to a dividend in proportion to the number of shares held. This means that non-working shareholders would participate in any dividend declared. This lack of flexibility can be countered by creating different classes of share with different dividend entitlements. Cashflow PAYE and national insurance are payable monthly; corporation tax is payable nine months and one day after the companys year end. Dividend upper and additional tax is payable on 31 January after the end of the tax year in which the dividend is paid (payments on account may be required). Pensions Payments of additional salaries can enhance the contributions that can be paid to pension schemes. For certain types of scheme, benefits can be based on the pay for the best three out of the last ten years before retirement, so planning for high salaries can be used to advantage.
Posted on: Thu, 14 Nov 2013 09:50:23 +0000