Peter Rayney looks at the ‘bonus v dividend’ decision faced by many company owners in the light of the recent dividend tax increases.
For a number of years, owner-managers have typically extracted most of ‘their’ company’s profits through dividends. In many cases, the owner manager would take a ‘reasonable’ salary, leaving the balance of their ‘drawings’ to be taken as a dividend payment.
However, the ‘old’ dividend tax regime was abolished on 6 April 2016, and under the ‘new’ regime dividend tax rates increased (i.e. effectively by 7.5% across each tax charging band).
As a quick recap, dividend income is taxed at the highest slice of income. Dividends no longer carry a tax credit, but each individual taxpayer has a £5,000 nil rate band. The 2017/18 dividend tax rates are as follows:
Taxable dividend income received Tax rate
Up to £33,500 7.5%
Between £33,501 and £150,000 32.5%
Above £150,000 38.1%
In the light of these changes, owner-managers naturally asked their accountants or tax advisers whether their existing profit extraction methods still made sense. The general conclusion was that it remained tax efficient to still pursue the ‘low salary/high dividend’ model, but the tax savings obtained by paying dividend were less than they used to be under the previous system.
The tax and National Insurance contributions (NICs) currently saved by dividends are best seen through a few examples:
Example 1: Bonus v dividend – owner manager’s marginal rate is 40%
Robert owns 100% of the shares in Zimmerman Ltd. He already draws a salary of about £52,000 from his company. Assume that there are surplus profits of £100,000 available for the year ended 31 March 2018.
Assuming that £100,000 is available for extraction, the tax and NICs payable under the two routes - bonus or dividend – are shown below:
Bonus Dividend
£000 £000
Surplus profits 100 100
Less: Employer’s NIC @ 13.8% (12)
Less: Corporation tax @ 19% (19)
Received by Robert 88 81
Income tax @ 40%/32.5% (35) (25)*
Employees’ NIC @ 2% (2)
Net cash available 56
Effective rate 49% 44%
* Dividend tax - £81,000 - £5,000 (dividend nil rate band) = £76,000 x 32.5% = £24,700
Example 2: Bonus v dividend – owner managers’ marginal rate is 45%
Reginald has always held 100% of the entire issued shares of Dwight Ltd. Assume he consistently has taxable income of £400,000 (including a salary of £50,000) from various sources. Dwight Ltd is likely to have surplus profits of £100,000 for the year ended 31 March 2018.
The ‘bonus v dividend’ comparison is shown below:
Bonus Dividend
£000 £000
Surplus profits 100 100
Less: Employer’s NIC @ 13.8% (12)
Less: Corporation tax @ 19% (19)
88 81
Income tax @ 45%/38.1% (40) (29)
Employees’ NIC @ 2% (2)
Net cash available 46 52
Effective rate 54% 48%
* Dividend tax - £81,000 - £5,000 (dividend nil rate band) = £76,000 x 38.1% = £28,956
Planning Tip:
Assuming the owner manager takes a suitable salary, it will generally be best for them to extract the remainder of their ‘profits’ through a dividend. If they wish to provide for their pension, it is best to arrange for a company pension contribution (since this does not require relevant earnings) and is therefore especially efficient where large dividend payments are taken.
