Business Briefs · Would you like to run a Limited Company?
Company Bonus or Dividend?
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.
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As mentioned above, income tax is chargeable on all profits withdrawn from a company.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 equal to 22.5% of the gross dividend.
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 11% (2009-10) on earnings between the earnings threshold and the upper earnings limit, and 1% on earnings above this without any upper limit. Employers pay 12.8% (2009-10) on all salaries above £5,715 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 company’s year end. Additional income tax on dividends is payable on 31 January after the end of the tax year in which the dividend is paid (payments on account may be required).
It is clear that many factors must be considered when deciding whether directors should be paid by dividend or salary/bonus. In practice, a mixture of each is usually the best course..
Care and professional advice should be taken in all cases. An individual’s and company’s specific circumstances must be reviewed and the advice tailored to the particular needs.
