If you own and run a company, how should you pay yourself in the 2016-17 tax year?
In recent years, the most efficient way for owner run businesses to pay themselves personally has been to take a salary up to the lower earnings limit for national insurance, and then take the reminder as dividends, business profits permitting.
This preserved the national insurance credit entitling the individuals to benefits and the state pension, but also allowed them to take advantage of the lower tax rates on dividends as opposed to those imposed on salaries.
However, from the 2016/17 tax year, HMRC are starting to correct this imbalance.
From 6th April 2016 the 10% notional tax credit on dividends has been abolished and replaced with a £5,000 tax free dividend allowance instead, meaning most taxpayers will be paying an extra 7.5% per annum.
- Basic rate taxpayers will now pay tax on dividends at 7.5% instead of 0%
- Higher rate taxpayers will now pay tax at a rate of 32.5% instead of an effective rate of 25%
- Upper rate tax payers will now pay at 38.1% instead of an effective rate of 30.55%
This change is particularly harsh on those who work with their spouses in family run companies, as a couple splitting £100k per year will be around £5,000 worse off.
Higher Rate Tax payer
The example below shows a company with profits of £100k, and compares taking the money as dividend or salary. It assumes that the taxpayer is on the higher rate, and has other income to utilise the personal allowance and basic rate band:
|Profit charged to tax||nil||100,000|
|EEs NIC||12% & 2%||5,110|
|Total tax and NIC||51,799||44,375|
|Effective tax rate||51.8%||44.4%|
Basic Rate Tax Payer
The example below shows a company with profits of £50,000 to distribute. It assumes that the taxpayer has no other income and that the personal allowance and basic rate band are fully available to them:
|Profit charged to tax||nil||50,000|
|EEs NIC||12% & 2%||4,188|
|Income tax||0% & 7.5%||1,800|
|Total tax and NIC||17,620||11,800|
|Effective tax rate||35.2%||23.6%|
The above examples show an either or scenario, when in reality a combination of salary and dividends is the best way to protect your NI credit and be most tax efficient.
Although the dividend route is still the most tax efficient way of paying, it’s not as good as it once was.
Your decision may well be impacted by what is available to take.
In order to take dividends, there has to be enough distributable reserves (profits) to pay the dividends, whereas salaries can be taken and turn a company loss making, although this is obviously not a long term solution with its impact on cashflows. If a company falls under the IR35 or Managed Service Company rules so that it it is subject to PAYE and NIC then there is little point in paying dividends.
There is still roughly six weeks until the end of the tax year year on 5th April, so make sure you make any necessary amendments to salaries and dividends before then.