Salary vs. Dividends – The Facts for Directors

Do you own your own company?

As a company owner you are in a favourable position: you benefit from being rewarded as a director and a shareholder.

Directors take a salary from the company. Shareholders draw dividends. By splitting your income between salary and dividends you could generate large income tax and national insurance (NI) savings. By managing your salary and dividends effectively you could find yourself in a lower tax bracket with more spendable income.

What is the difference between salary and dividends?

  • Salaries can be paid even if the company is making a tax loss
    • A salary is tax deductible
    • A salary generally qualifies for corporation tax relief, whilst dividends do not
    • Salaries are instantly subjected to income tax and NI via PAYE
    • Salaries are classed as earnings and therefore affect pension contributions
  • A dividend requires the company to be in profit
    • Being paid a dividend does not reduce the company tax bill as dividends are paid from a company’s post-tax profits
    • Dividends are not subject to NI
    • Income tax on dividends is collected at a later date via self-assessment
    • Dividends are not classed as earnings

Non-tax factors to consider

Make sure you consider the cashflow and working capital requirements of the business before you give yourself a salary or dividend. Dividends can be declared and left unpaid. This strategy saves the director/shareholder’s annual tax-free dividend allowance from being wasted and also helps the company’s cashflow. However, if the director/shareholder is a higher-rate taxpayer income tax will still be payable on dividends declared but not paid.

If the company is insolvent, or the payment of a dividend will render the company insolvent, then dividends should not be declared. Also consider that a large salary or bonus will depress the company’s profits, affecting the company’s ability to borrow. On the other hand, a low salary may make it difficult for you as an individual to borrow. Not all lenders will acknowledge dividends.

The value of a company is often based on a multiple of its after-tax profits. However, a small majority shareholder’s stake is often valued according to the dividend history of the company. Therefore, a consistent or steadily increasing annual dividend will enhance the value of the shares.