Posted by admin - August 13, 2015 9:03 am Salary/Dividend – What has changed?

Up until now it has been tax efficient for individuals employed by their own companies to remunerate themselves by taking a low salary topped up by dividends but following the recent budget, is this still the case?

For the salary aspect, the director/shareholder can decide how often they would like to be paid, normally either on a weekly, four-weekly or monthly basis. If an employee receives a salary between £8,060 and £42,385 they will pay Class 1 National Insurance Contributions (NIC) at 12%.on the earnings in that range. On earnings above this level, the employee will pay Class 1 NIC at 2%. The company will pay Class 1 NIC at 13.8% on the earnings above £8,112 with no upper limit. By paying NIC the employee becomes entitled to statutory benefits. Most businesses are eligible to receive an Employment Allowance each year of £2,000, which is offset against the employer’s NIC bill. With the personal income tax allowance currently at £10,600, there may be an overall saving by suffering some employee’s NIC at 12% and reducing corporation tax by 20%, but it will depend upon whether the employee has income from other sources, or whether the company has other employees to make use of the Employment Allowance.

With regard to dividends, the individual can decide when to receive a dividend as they are available at any time provided that there are available profits in the company accounts. To take a dividend a directors’ meeting needs to be held, minutes of the meeting need to be taken and tax vouchers produced. Dividends attract a tax charge of 10%, 32.5% or 37.5% depending on whether the individual receiving them is a basic rate taxpayer, a higher rate taxpayer or pays tax at the additional higher rate. Currently a 10% “notional” tax credit is available to offset and no further tax is payable by a basic rate taxpayer.

From April 2016, however, there are two proposed changes* that will have a significant impact on the above:

  • The Employment Allowance will increase to £3,000 but the allowance will no longer be available to companies where the only employee is a Director; and
  • The “notional” tax credit attached to dividends will be abolished. Instead each individual will have a dividend tax allowance of £5,000. Dividend income exceeding this threshold will be taxed at 7.5% for basic rate taxpayers, 32.5% for higher rate taxpayers and 38.1% for additional higher rate taxpayers.

So in the future, will it still be worth paying a lower salary topped up with dividends? In short, yes, as the overall tax/NIC bill will still be less, but the overall savings will be much reduced from 2016/17 onwards.

Whilst writing, please be aware that the salary/dividend balance does have an impact with regard to pension contributions which is something that must be considered carefully when planning for the future. The reason for this is because if dividends are the individual’s only source of income they will not count as relevant earnings and the maximum gross amount that they could contribute to a pension would be £3,600 per year (£2,880 net). It is also important not to overlook paying a salary above the lower earnings limited (LEL – currently £5,824) so as to count as a qualifying year for future State pension entitlement.

Please note:

The above is based upon our understanding of the proposed changes announced in the July Budget. These changes are subject to Royal assent and have therefore yet to be enacted. We will keep you posted of any future changes. If you need any additional assistance on this matter then please do contact your local MFW office.