Salary v dividend

Newsletter issue - March 2017.

The questions surrounding the issue of how best to extract profits from a company in a tax-efficient manner remain as popular as ever. Despite the introduction of the dividend allowance, and the personal savings allowance, extraction by remuneration and by way of dividend remain the two most widely used methods. The tax effects of these methods may be broadly contrasted as follows:

The main point to note is that the question of how best to extract profits from a company is rarely straight-forward and will be different in nearly every case. Seeking advance professional advice is always highly recommended.

It must be remembered here that payment of a salary will give rise to a liability to National Insurance Contributions (NICs), whereas payment of a dividend does not.

In considering the options, a number of other factors should also be taken into account:

Given that dividends are treated as distributions of profits (after taking into account payments of salaries and wages), payment of a reasonable salary may be considered before thinking about a potential dividend payment. The situation will vary from company to company and there is no set rule. Seeking professional advice is recommended before any action is taken.

In deciding how profits are to be extracted, the following aspects should be considered:

For income tax purposes, and within family-owned companies, it is generally desirable to spread income around the family to fully utilise annual personal allowances and to take full advantage of nil and lower rate tax thresholds, wherever possible. The term 'family' includes all individuals who depend on a particular individual (e.g. the owner of the family company) for their financial well-being. This may include not only the spouse, civil partner and children but also aged relatives, retired domestic employees, etc. Care must be taken in this area not to fall foul of the 'settlements' legislation and other anti-avoidance measures in force at the time. Once again, professional advice is always recommended in advance of making any payments.

Distributions (usually dividends) from jointly owned shares in close companies are not automatically split 50/50 between husband and wife, but are taxed according to the actual proportions of ownership and entitlement to the income.

Possible methods of spreading income around the family include employing a spouse and/or children, waiving salary (to increase profits available as dividends) or dividends (to increase the amounts available to other shareholders), and transferring income-producing assets.

Some distributions of income to family members will not be beneficial for tax purposes. The following points require careful consideration:

In the longer term, there is a risk that, at some future date, the relative advantages of each extraction method might be reversed at a time when the flexibility to switch between the two methods is restricted. Currently though, using a mixture of salary, benefits and dividends, which can be varied according to individual circumstances, remains the most sensible option.

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