When business owners are discussing their tax affairs with their advisers, they will focus on the effective rate of tax being suffered on the amounts they are withdrawing from the business.
As they are owners of the business, the overall tax burden is relevant as everything that is left over in the company is also theirs, so this means corporation tax and employers national insurance suffered by the company need to also be considered alongside income tax and national insurance suffered by the individual.
Now there is a new consideration: the health and social care levy, which is suffered by both the company and the individual.
The recent introduction by the chancellor of the health and social care levy at 1.25 per cent increases the rate of tax on dividends by 1.25 percentage points, as well as national insurance contributions by employees and employers by the same amount.
However, the key questions are: does this change existing remuneration strategies and what else should be considered as part of the conversation? And what are likely changes in the future?
The current position is that for the 2021-22 tax year the effective rate of tax when taking a dividend or salary from a company is as follows:
Taxpayer tax rate | Effective rate of tax for dividend | Effective rate of tax for salary |
Basic rate | 25.08% | 40.25% |
Higher rate | 45.33% | 49.03% |
Additional rate | 49.86% | 53.43% |
As can be seen from the above, the effective rate of tax is slightly cheaper for dividends and therefore the position has been for some time that most owner managers remunerate themselves with a small salary to utilise their personal allowance and then additional amounts are drawn as dividends.
Other factors do influence these decisions as a company must have distributable reserves to allow a dividend to be paid and if the company is relatively young in its life cycle or the owner requires regular earnings for personal credit purposes then a salary may well be a better practical option than dividends acknowledging the small tax differential.
The effect of the introduction of the health and social care levy is to increase the effective rate of tax for both a salary and dividends. The comparable figures for 2022-23 are as follows:
Taxpayer tax rate | Effective rate of tax for dividend | Effective rate of tax for salary |
Basic rate | 26.09% (+1.01%) | 41.98% (+1.73%) |
Higher rate | 46.34% (+1.01%) | 50.67% (+1.64%) |
Additional rate | 50.87% (+1.01%) | 55.02% (+1.59%) |
The differential between dividends and salaries has grown further and it would appear that future remuneration strategies will continue to utilise dividends when practical considerations are met.
Exploring alternatives
However, with these effective rates of taxes continuing to increase many business owners may start to explore alternatives. Currently contributions to personal pension plans can be made by companies for business owners without attracting national insurance and receiving a corporation tax deduction.
While there are limits on the amounts that can be contributed, this is an obvious alternative to the tried and tested dividend route, which would allow profit extraction with a lower effective tax burden – while acknowledging that these are funds that the business owner is unlikely to be able to utilise for several years.
With the announcement that corporation tax rates are set to increase from 2023 onwards, the effective rates of tax on dividends for additional rate taxpayers will increase to an alarming 54.51 per cent compared to just 40 per cent six years ago, and will make many business owners challenge the mantra of the Conservatives of being a low-tax party for the entrepreneurs of this country.
