Company Director’s Pay – Dividends or Salary

There are numerous ways in which company directors can pay themselves in a tax-effective manner. However, the most topical debate raging at the moment concerns the notion of taking a high proportion of your earnings as a dividend rather than via a salary.

Dividends are National Insurance (NI) exempt. They thus represent an attractive method of taking funds out of a business given the recent rises in NI contributions affecting employees and employers alike. Yet paying yourself in this manner will not suit everyone.

“The general rule of thumb is that for any company paying corporation tax at a lower rate – i.e. 19% or 20% – it is better to pay dividends. If the company pays corporation tax at over 30% though you qualify for NI relief. At 30% this outweighs the dividend benefits,” explains Darren Spectreman of Glazers Chartered Accountants.

Usually firms generating a profit of more than £300,000 a year fall into this category. There are concerns, however. For one, as Spectreman suggests, ‘you have to be careful of Revenue attacks, particularly if you run a family business.’

This is because the Inland Revenue can be far from happy when encountering firms owned by husband and wife teams, where only one actually works for the business but both draw payment.

As a general principle though, the Inland Revenue seems to have few objections to directors taking the majority of their fees through dividends. In a recent newsletter, it even conceded that in certain circumstances ‘it may be more advantageous to pay a dividend, rather than a salary.’

Another concern is the level of pension contributions you are able to make if you pay yourself in dividends. In the past, limiting your salary had an adverse effect on the level of pension contributions you were able to make.

The introduction of stakeholder pensions alters this somewhat, capping annual contributions at a percentage of earnings – dependent on age – or £3,600, whichever is greater.

One way of getting around this – at least for a while – is that the Inland Revenue permits you to use your best year’s earnings, out of the last five, to set the level of pension contribution. So if, for example, a 40-year-old director took a £30,000 salary in the first year, he/she would then be able to make contributions at 20% of this amount (i.e. £6,000) for the next four years. This level would hold regardless of the mix of salary and dividends adopted throughout the remainder of the period.

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