Salary or Dividends?

UK Tax rules over recent years have made it tax efficient for Directors of small companies to predominantly take their remuneration by way of a small salary and dividends. Since the change of dividend rates in April 2023, the best way to draw funds from a business is not as clear. Having considered the Salary or Dividends decision, some Directors have chosen to join the payroll, and withdraw their cash by way of a salary.

As with any decision, there are pros and cons to the Salary or Dividends debate, so lets take a look at them in turn.

The Pros of taking a salary rather than dividends:

1. Any tax due on income received is paid almost immediately, through the payroll, rather than in July and January each year. There’s no need to save a proportion of your income and pay it over through the Tax Return system.
2. If all of your income is through payroll, you can (eventually) be removed from the Self Assessment system, so no longer need to submit a Tax Return. (Please be aware that this isn’t necessarily an easy thing to achieve, and is dependent on HMRC updating their systems!)
3. There is no need to calculate the legality of any dividend amounts against profits in the business, so you will know how much money you will have coming in every month and can have an accurate domestic budget.
4. If you need to apply for a mortgage , it can be much easier to meet affordability criteria if you can supply payslips to prove your income rather than show dividends, a direct reflection of the lack of predictability for dividends.
5. Any salary is (usually) set on an annual basis, so the business can plan for those payment amounts much more easily.
6. Taking your income as salary means you can utilise the methods outlined in Profit First more easily and pay yourself first. Many business owners who have moved away from dividends pay themselves a couple of days before the staff each month which can make them feel more valued.

The Cons of taking a salary rather than dividends:

1. Depending on the level of profits the business is generating, and that’s available to be drawn, you can end up paying a little more tax as a result of moving to a salary. There is a ‘sweet spot’ for both salary and dividends where each can be most tax efficient, but the preferred option will depend on individual circumstances and the salary amounts involved.
2. By taking a salary and avoiding the twice yearly tax payments, you don’t have the use of the tax money you’ve set aside in the interim and before the tax payments are due through the Tax Return system.
3. If the business is seasonal and that seasonality means the business has a cash surplus when tax payments are usually due, effectively taking those funds at quieter times may cause cash flow pressures that weren’t experienced before.

As you may have gathered, there is no easy answer to this one!

If you’re considering a move from a small salary and dividends to an ‘all salary’ position, please get in touch and we’ll take you through the various calculations for your unique circumstances, and help you make the best decision.