It is a question we are frequently asked – how should I split the income from my limited company between salary and dividend?  In the example of a single director company the answer is quite straightforward.  For the financial year 2015/2016 the approach is outlined below:

Types of income and taxes

  • Salaries and bonuses are subject to National Insurance (there are two types of National Insurance – employees and employers) but are eligible for Corporation Tax relief.  For the tax year 2014/2015, an employment allowance was introduced to remove the first £2,000 of employers National Insurance and it is still in place for 2015/2016.
  • Dividends are not subject to National Insurance, but must be paid out of profits after the company has paid its Corporation tax bill.  Paying a dividend does not help the company’s tax position because the company’s taxable profit is calculated before the dividend is taken into account.
  • The rates of income tax on Dividends is different from those applying to salaries or bonuses.  The rate tables are detailed below.
  • Income tax and National Insurance is payable on salaries and bonuses and is collected through the PAYE system.  Any income tax due on dividends is collected via self assessment and this is generally at a later date.

 

Tax tables for 2015/2016

Marginal   dividend tax rates

 Rate

Income   up to £42,385

0%
Income   from £42,386 to £100,000

25%
Income   from £100,000 to £121,200 (removal of personal allowance)

37.50%
Income   from £121,200 to £150,000

25%
Income   over £150,000

30.60%

 

Personal tax rates
Band

£

Rate
Individual   personal allowance

0-10,600

0%
Basic   rate tax

10,601 – 42,385

20%
Higher   rate tax*

42,386 – 150,000

40%
Additional   rate

>150,000

45%

 

The answer

Based on a simple example of a limited company with:

  • one Director
  • profits less than £300,000

 

the tax efficient answer is to pay yourself £10,600 in salary and dividend the rest.  This will result is a small amount of PAYE and employee NI being paid through the company payroll and any additional tax resulting from the dividend will be collected through self assessment.

As stated this is a simple example and does not consider:

  • Other types of income e.g. pensions, rental income, savings
  • Pension contributions
  • Distributable reserves – dividend must be legal!
  • IR35 and deemed payments
  • Companies with profits in excess of £300,000
  • Cashflow implications
  • Director loans
  • Multiple Directors in a company
  • Associated companies
  • Entrepreneurs’ relief

I still do not understand!

The salary vs. dividend needs to be reviewed on a case by case basis.  As a client of Arcata we provide a salary vs. dividend review on joining and then each new tax year ensuring you are tax efficient!