Following on from the posting “What Should You Earn” I thought it worth putting together a short note on this matter. There is always confusion about whether Dividends or Salaries are the best route and there are also a number of other considerations that at first aren’t always obvious. I asked for a little help from my friends at Littlejohn, a mid tier accounting firm, to give me some assistance in getting clarity on the position.

When considering how to extract profits from a company, an owner manager may consider taking a salary (which should attract Corporation Tax relief, but is subject to PAYE and National Insurance) or taking a dividend, which does not give the company relief from corporation tax but is only subject to income tax, at a lower rate than for a salary.  The most tax efficient mechanism overall will vary, depending on the level of company profits and the income level of the manager.

In many cases, the main (and sometimes only) issue that will be considered in deciding how to extract funds from the business is the immediate tax charge.  However, whilst the raw tax costs are important, there are other factors that should also be considered when planning a policy for profit extraction and remuneration.  Among other issues are:

• Ensuring a basic salary is received to retain entitlement to National Insurance based benefits, such as the State pension.
• Payment of non-cash benefits (such as Contributions to a Pension Scheme).
• Ensuring any remuneration paid is allowable in the calculation of profits for Corporation Tax purposes.
• The effect of the National Minimum Wage on any salary arrangements.
• The effect of receiving salary income on the recipients ability to make pension contributions.

Littlejohn have helpfully put together their thoughts in a short memo on the subject which can be found on their website http://www.clblf.com/articledetail.php?article_id=76&year

The issues involved can be complex and will depend on the specific circumstances of the manager and the company concerned, and therefore will almost certainly require some discussion before a decision is made.  However, as shown in the Littlejohn example, the basic position for a small company, rewarding a basic rate taxpayer is that a dividend payment will most likely be the most tax efficient route.

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