In the corporate world, a limited company is treated as an entirely separate legal entity from its owners and from the directors responsible to run the company. That means the director or the owner will have a separate income tax assessment and the company will have its own corporation tax assessment.
That being said, a director cannot just take money out of the company in the form of drawings and has to either pay himself a fixed salary or income in the dividend form. Here is what you need to do in order to establish a tax-efficient director’s remuneration system.
Tax-Efficient Combination of Director’s Salary and Dividend for Tax Year 2022/23
Like every other taxpayer, directors of limited companies are also bound to give tax on their income, regardless of whether it is in the form of salary or dividend.
Before we jump into the details of structuring a director’s remuneration system that reduces your tax bill, let’s explore the available allowances first.
In the UK tax system, every taxpayer can have a tax-free income of up to £12,570, known as the personal allowance. In addition, there’s a dividend allowance of £2,000 available to individuals with dividend income. That means you can legally earn £14,570 as a director each year without paying any tax. However, the story has more to it..!
Since dividends are paid from the after-tax profits, your company would have already been assessed on the income —Corporation tax is 19% for the tax year 2022/23, and you would need to pay an additional tax on the dividends that exceed your personal and dividend allowance.
Alternatively, you can pay yourself a salary since a director is essentially an employee of the company. The good thing about taking salary instead of dividend is that salary is a deductible expense for companies and the amount is taxed as an employment income in the director’s income tax computation.
However, when the salaries exceed the NIC threshold (explained below), then an additional NIC tax is charged on both the director’s employment income and the salaries that the company gives.
In a nutshell, either of the remuneration systems has pros and cons attached, and to formulate an optimal strategy that ultimately reduces your tax liability, you need to make sure you avail every possible tax reduction opportunity.
Ideally, you should get more proportion of income in the dividend form because as per national insurance contribution (NIC), all employees (including directors) are bound to pay tax on their salaries but not on their dividend income. However, it does not mean that the director will only take dividends to be tax-efficient, as he is also the employee of a company, he will be getting a fixed amount every month which should be taxed accordingly.
Regardless of the type of income, an employee (director) will be taxed according to the predefined set of rules set by HMRC.
Before jumping into the specific rules of salary or dividend tax 2022-2023, let’s first discuss the general criteria:
- Every individual will receive a tax-free personal allowance of £12,570.
- The threshold for basic rate taxpayers will remain at £50,270.
- On dividend incomes, the tax-free allowance will remain at £2000.
The tax rate for dividend income:
The dividend tax rates have been increased by 1.25% for the tax year 2022/23. This will apply to all UK taxpayers.
Pros of having a Combination of Salary and Dividend 2022-2023
If you are a director of a limited company and acquire shares of the company, you are the director as well as the owner of the company. Following are the ways through which income becomes tax efficient for you:
- Less salary and more dividend: it is beneficial as dividend income has no liability of national insurance contribution.
- Director’s salary: paying salary to the director will be shown as an expense in the income statement which will reduce taxable income. It can also be claimed as a tax deduction.
- It is not necessary to distribute all the post-tax income as a dividend, the company has the option to retain it, in this way it can claim business asset disposal relief on the closing of the company.
National Insurance Contribution on Director’s Salary
| Lower earnings limit | The lower-earning limit is £533 per month or £6396 per Anum according to the tax year 2022/2023. If you are paying a salary above this limit, you can keep the entitlement to start a pension and state benefits. |
| Primary threshold | From July 6. 2022 the primary threshold is £1,047.50 per month and £11,908 per annum, when a taxpayer will exceed this limit it automatically becomes liable to the employee’s national insurance. |
| Secondary threshold | The secondary threshold limit is £758 per month or £9,100 per annum, when this level is exceeded by the company, the company will start paying the employer’s national insurance. |
The Personal Allowance Scheme
If you are eligible for employment allowance (If the company’s class 1 national insurance contribution is not more than £100,000 in the previous tax year while running any business or charity, it will be eligible for employment allowance) which is now £5000, and did not fully utilize it, you can pay the director’s salary up to the personal allowance limit which is £12,570. So, the directors plus owners are advised to pay themselves a salary up to the personal allowance limit, and the rest of the money, they should take as dividend income.
The National Insurance Scheme
Other than above mention personal allowance scheme, there is the national insurance scheme related to the best combination of salary and dividends for the year 2022-2023 from a tax perspective, this scheme advises the director to pay himself a salary up to the limit of above-mentioned employer’s national insurance contribution threshold. This is less than the employee’s national insurance contribution scheme. Directors should get the rest of the income in the form of dividends.
The 2022-2023 Dividend Tax Rate Threshold
| THRESHOLD | DIVIDEND TAX RATE | |
| PERSONAL ALLOWANCE | £0-£12,570 | 0% |
| BASIC RATE TAXPAYER | £12,570-£50,270 | 8.75% charge but on the dividends above the allowance for dividend which is £2,000 |
| HIGHER RATE TAXPAYER | £50,271-£150,000 | 33.75% |
| ADDITIONAL RATE TAXPAYER | More than £150,000 | 39.35% |
As salary is paid every month, the dividend cannot be paid like this. For dividends, there should be a board meeting before announcing a dividend. No matter if you are the only director of the company or own the company, if the company is registered, there must always be a board meeting before announcing a dividend.
Best Combination of Director’s Salary and Dividends For Tax Year 2022/23
Now, let’s connect the dots and practically check the tax implications of both remuneration strategies for directors. Suppose that your company has a taxable income of £40,000 for the tax year 2022/23 and being the director, you are curious as to how to pay yourself in a tax-efficient manner. Here are your 3 options:
- Option A -Pay yourself the whole £40,000 salary
- Option B -Pay yourself the whole £40,000 in dividends
- Option C -Pay yourself the mix of dividends and salary
Option A – Paying yourself a Salary
If you pay yourself a £40,000 salary, the company’s total taxable income is £40,000. Remember the salary expense is an allowable expense. So the corporation tax will be nill.
Director’s Income Tax
Employment income: 40,000
Personal Allowance: (12,570)
Taxable Income: 27,430
Income Tax (27,430 x 20%): 5,486
NIC ((40,000 – 9,568)X12%): 3,652
Total tax liability of director: 9,138
Employer’s NIC=
Employment allowance= £4000
40,000-4000= 36,000
8840*0%= £0
36,000-8840=27,160
27,160*15.05%= £4087
Total Tax under Option A= £13,225
Option B – Paying yourself Dividends
If you pay yourself the whole £40,000 in dividends, the income will be taxed twice -your company will pay corporation tax on the income since the dividend is not an allowable tax expense and you will receive the remaining amount as dividend income. Here’s the total tax computation of the company and you (the director):
The corporation tax rate is 19% for the tax year 2022/23 and the company will pay a flat 19% corporation tax of £7,600 (£40,000*19%). You will receive the remaining £32,400 (40,000-7,600) in dividends and will be taxed as follows:
Dividend Income = £32,400
Personal Allowance = (£12,570)
Dividend Allowance (2,000)
Taxable Income= £17,830
Since it falls within the basic rate band, the dividend received will be taxed at 8.75%.
Tax liability = £1,560 (17,830*8.75%)
Total Tax Liability using option B = £9,160 (7,600+1,560)
Option C – Tax-Efficient Mix of Dividend and Salary For Directors 2022/23
By following the Tax-efficient remuneration basis:
As the rates of non-savings income are higher than those of dividend, the director must pay himself salary up to Class 1 Primary NIC’s exempt threshold which is 9,568 as per FA-21. So,
Employment income: 9,568
Personal allowance: (9,568)
Income tax liability: 0
Class 1 primary nic (9568-9568): 0
Dividend: 30,432
Dividend nil-rate band: 2,000
Remaining personal allowance (12,570-9,568): 3,002
Taxable income: 25,430
Income tax of Director (25,430 x 8.75%): 1,907
Since dividends are paid from the after-tax profit, the company will pay corporation tax on the profit. The corporation tax rate is 19%.
Income= £40,000
Less:
Salaries Paid= £9,568
Taxable Income= £30,432
Corporation Tax= £5,782
Total Tax Liability under option C = £7,689
Option C is the best combination of director’s remuneration and using this model, you can significantly reduce your tax bill. The tax liability under Option C is £1470 (9160-7689) lower than Option B, and £5,536 (13,225-7689) lower than Option A. Therefore, the most tax-efficient director’s remuneration for the tax year 2022/23 is the mix of dividend and employment income whereby you pay yourself salary up to the NIC threshold and receive the rest as dividends.
