For shareholders, dividends may form a critical element of your salary strategy and tax planning, to minimise your tax liabilities.
To extract profits tax-efficiently from your business, you may use a combination of:
- Salary – Typically set at or around the Personal Allowance of £12,570 to minimise Income Tax and National Insurance Contributions (NICs).
- Dividends – Paid to owner/director-shareholders and not subject to NICs.
- Pension contributions – You can claim tax relief on private pension contributions of up to 100 per cent of your yearly earnings.
- Director’s loans – You or a close family member receives money from your company, which may be tax-free for you as an individual, depending on how it is repaid.
Dividends can be a great option because they are currently taxed at a lower rate than earnings which are subject to Income Tax. The tax is levied depending on your Income Tax band:
- 8.75 per cent for those in the Basic rate tax band
- 33.75 per cent for those in the Higher rate tax band
- 39.35 per cent for those in the Additional rate tax band
For this reason, many shareholders choose to take a relatively low salary in addition to dividends, to remain in the basic rate band and so minimise tax on dividend payments.
Could dividend taxes change?
Dividends have been a growing target for HM Revenue & Customs (HMRC) in recent years, with the tax-free allowance falling steadily from £5,000 in 2016/17 to £500 in 2024/25.
Having pledged to avoid raising taxes on income, the Government may seek to levy further tax on wealth in the Autumn Budget instead, which could encompass dividends.
Should the Government decide to tinker with dividends, the two most likely outcomes are the tax-free dividend allowance being removed altogether, or otherwise the rates of tax on dividends being increased.
Should you change your strategy?
If you have a typical tax-efficient profit extraction strategy, with a low salary and dividends, then this is likely to remain the best approach to optimising your tax liabilities – but this is highly dependent on whether tax rates on dividends remain the same.
If tax rates remain unchanged, any dividends will still be subject to a lower rate of tax than if they were taken as salary, even without a tax-free allowance. However, a rise in rates could result in a significantly higher tax liability.
In this situation, you may consider another method of profit extraction, such as making additional pension contributions if you have not used your full tax-free pension allowance.
For advice on managing profit extraction, salary and dividends, please contact our team today.
