Dividend Tax Rate Changes
Since the recent increase in the dividend tax rate, it may well be worth taking time to re-evaluate your remuneration strategy.
This article outlines some of the pros and cons of individuals paying themselves dividends from their company, as well as the risks involved.
What are dividends?
A dividend is a payment of profits (after corporation tax) to shareholders of a company. Business owners can pay themselves through a salary or dividend, or a combination of the two. Profits extracted from the company can be spent freely, whereas funds reinvested must be applied wholly and exclusively for the benefit of the company.
What are the benefits of paying yourself dividends from your company?
Historically it has been beneficial to extract income in the form of dividends, as dividends have attracted lower rates of income tax than being paid a salary.
Additionally, individuals have a tax-free dividend allowance (currently £2000) which means that tax is only payable on dividends above this rate. This allowance is on top of the income tax personal allowance, so it can be advantageous to utilise these allowances by taking income using a combination of both salary and dividends.
Investors should check their other investments where dividends are received, as these may mean that part or all of the tax-free dividend allowance for the given period has been used. It is sometimes possible to pay dividends to your spouse to access their tax allowances, if they are a full shareholder in their own right.
Paying yourself a dividend (as opposed to a salary), will be exempt from National Insurance contributions for both you and the company/employer. However, a dividend is paid out of profits after corporation tax, and so business owners should take advice to ensure their position is optimised.
Who benefits from dividend payments?
Dividends are currently taxed at lower rates than a salary, with a top dividend rate of 39.35%, compared with a top salary tax rate of 45%. But dividends are paid after corporation tax, which is also increasing to a 25% headline rate in 2023 (but with marginal relief between £50,000 and £250,000 of company profits).
Business must be making a profit (after tax) to make dividend payments. Provided this is the case, one way in which companies can benefit from paying dividends is through shareholder loyalty and retention of investors.
For external investors, a big advantage of receiving a dividend is that it represents a return on investment. In times where stock prices can be volatile, the payment of dividends can provide reassurance to investors and more money to invest.
In some cases, if owner managers do not need to take moment out, then it may be best to keep the money in the company to reinvest at lower tax rates. However, tax will still need to be paid when you eventually extract the money or close the company.
What are the risks and disadvantages?
Salaries are an allowable expense which can be deducted from a company’s corporation tax liability, whereas dividends can only be paid out of company profits and are subject to income tax once paid to the shareholder.
Dividends are not treated as ‘earnings’ for pension contribution purposes.
If you take a dividend that is not covered by profits, there is a risk that you will have taken out a company loan which must be quickly repaid.
Retaining money in the company can be sensible in cases where funds are needed for future purposes or growth. It is also sensible to factor in unexpected situations like the Covid pandemic, and periods of low cash flow whereby paying out dividends will impact the company’s ability to make a profit.
However, cash will not qualify for business property relief from inheritance tax on death, unless it is being retained for a clear purpose.
Setting a pattern of paying dividends can lead to that income being expected and relied upon. In the unfortunate event of divorce, the family courts can take regular dividend income into account as a matrimonial resource.
Furthermore, investors that rely on regular dividends as their main source of income should be aware that companies can reduce the amount of dividends paid (or not pay them at all).
Those who apply for income-based support (which has seen more attention due to the Covid pandemic) cannot include dividends as part of their income.
Are there any circumstances in which dividends payments are not a good idea?
Although directors are under a duty to deliver shareholder value, this has to be balanced against practical considerations. An example is if a business is being sold, paying a large dividend could risk impacting the deal.
There are also instances where receiving dividend payments may not be a good idea, including
- if you are going through a divorce or bankruptcy;
- if you are about to leave the UK to become non-resident, as it may be sensible to delay payment until you are non-longer UK tax resident; or
- if you are about to wind up the company then you could find that you benefit from a lower tax rate on liquidation (which can be liable to capital gains tax, not dividend tax), and potentially an ability to access business asset disposal relief at 10% for the first £1m of gains.
Dividend payments are just one way to extract money from a company – beneficial for some, but not for others. Given that taking money out of a company has a number of implications in the form of legal, tax and accounting, businesses should seek professional advice prior to making these decisions.
If you would like further information, please call us on 0203 915 8585 or email email@example.com.