Muras Matters: Bonus vs Dividend

Background

For those shareholders who are also directors or employees of a company it is often a consideration as to whether any additional remuneration is more tax efficiently paid as a bonus or as a dividend. This involves considering the tax cost to the company as well as the individual.

Over the last few years the general principle, subject to a shareholders individual personal circumstances, has been that payment in the form of a dividend tends to be slightly more tax efficient than a bonus.

With the rates of corporation tax due to increase to 25% from 1 April 2023 for profits above £250,000 and the introduction of marginal relief for profits between £50,000 and £250,000, Muras Matters this week takes an overview of the potential impact on the bonus vs dividend decision.

Detail

From 1 April 2023 corporation tax rates will depend on a company’s taxable profit levels as follows:

• For profits of £50,000 or less a company will continue to pay corporation tax at the current 19%;
• For profits between £50,000 and £250,000 a company will pay corporation tax at 25% reduced by a marginal relief, which equates to an effective tax rate of 26.5% on those profits between £50,000 and £250,000;
• For profits above £250,000 a company will pay corporation tax at 25%.

In many cases, an individual employee shareholder would take a ‘reasonable’ salary, leaving the balance of their ‘drawings’ to be taken either as a bonus or a dividend payment.

Based on the assumption that a shareholder is already fully utilising their tax free dividend allowance of £2,000, using the example of £10,000 of surplus profits to be extracted from a company the following table shows the total tax payable for a 40% tax payer at the different rates of corporation tax:

Using the same example, a basic rate taxpayer would be subject to an effective tax rate of 40.24% on the payment on a bonus and 25.08%, 32.01% and 30.63% respectively for a dividend.

Tax payers subject to the additional tax rate of 45% would see an effective tax rate of 53.43% on a bonus or 49.86%, 54.5% and 53.58% on a dividend.

The above example shows that the benefit of taking a dividend over a bonus is narrowing with the increased rate of corporation tax and for those whose company may be subject to the full corporation tax rate but with a marginal relief deduction, it maybe that a bonus will actually now be slightly more tax efficient.

The above is only an overview and each tax payer’s personal circumstances must be taken into account to determine the most tax efficient way of extracting profits from a company.

The increase in the corporation tax rate will also have an impact on those individuals considering incorporating, where the effective tax rate for a sole trader would be 29%, 42%, or 47% depending on income level.

If you have any questions regarding whether a bonus or dividend represents the most tax efficient profit extraction or if you are sole trader considering whether incorporation may be a favourable option, please speak to your usual contact at the firm.

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