2. What are the best Directors Salary and
Dividend Levels for 2016/17
Q. “I am a contractor freelancer operating through a limited
company and I use the low salary and dividend combination
of extracting money from my company. In previous tax years I
have made sure that I stayed below the higher tax threshold so
that I didn’t have any income tax to pay on my dividends, however
with the changes to how dividends are taxed from April 2016 with
the introduction of the Dividend Allowance, I am unsure if this is
still the best strategy. Can you advise what the best mix of salary
and dividends is for the 2016/17 tax year
i.e. from April 2016?”
A. “The 2016/17 tax year has
brought with it some major changes to
how dividends are taxed which in turn has an
effect on the optimum tax planning positions for directors
who are also shareholders. The dividend changes from April 2016
have been covered by us in a previous article but we will outline the
position again in this article.
Before getting into the detail we should say that this article is based on
what is currently known at the date of publication which is 10th February
2016. There is a budget announcement due on 16th March 2016 and whilst
there are no anticipated changes due which would affect the advice in this
article, if anything does change we will update this article accordingly.
How dividend taxation worked before
the 16/17 tax year
There used to be something called the
dividend tax credit which meant that from
a personal tax perspective a dividend had
to be looked at ‘gross’, whereas from the
company that was paying the dividends
perspective the dividend was seen as
‘net’. The dividend tax credit was 10%
and an example of how this worked was:
n Company pays a cash dividend of £1,000
n This is grossed up by 10% by calculating
£1,000 divided by 0.9 = £1,111.11
n It is the grossed up figure that is used for
personal tax calculations.
As long as your personal total income including
gross dividend income was below the higher
tax band (£42,385 for 15-16) then there was
no personal tax to pay on your dividends.
If you went over the higher tax band then the
element of dividend in the higher tax band
was taxed at 22.5% of the gross dividend
(which was effectively 25% of the cash
dividend). There were also additional tax
rates at the upper rate of tax as well as
other things that could affect personal
tax including child benefit.
How dividend taxation works from
the 16/17 tax year (from 6th April 2016)
The dividend tax credit has been scrapped,
this makes it easier to understand in our opinion.
A new dividend allowance has been
introduced which means that an individuals
first £5,000 of dividends are tax free.
Over and above this £5,000 the dividend
income is taxed as follows:
n If you have any un-used personal
allowance (£11,000 for 16-17) then
that element is tax free.
n Any dividends in the basic tax band (up
to £43,000 for 16-17) attract a tax charge
of 7.5%.
n Dividends above the basic tax band are
charged at 32.5%.
n Additional rates of tax will apply at the
upper tax band (£150,000 for 16-17).
3. Optimal levels of salary and dividends
for 16-17
Now we have explained how dividends will
be taxed from 16-17, we need to look at
what the most tax efficient levels of salary
and dividends are.
Taking a low basic salary with the balance
of income being extracted as dividends is a
common strategy amongst limited company
contractors, freelancers and small business
owners. The theory is as follows:
n Take a low salary no higher than the
personal allowance so that it does not
attract personal tax
n Make sure the salary is high enough for
national insurance purposes i.e. that it
counts as a years ‘stamp’ for your
national insurance history to help protect
your future entitlement to state pension
and benefits
n The salary is a tax deductible expense for
your business so corporation tax is saved
at 20% on the gross salary.
n Additional money is extracted as
dividends which does not attract national
insurance, therefore you are not paying
any more national insurance than you
need to be.
n Bear in mind that dividends are not a
pre-tax expense for companies so you do
not save corporation tax on dividends.
The question is then, what is
the optimal level of salary?
The introduction of the Employment
Allowance in April 2014 (it is being
increased to £3k from £2k in 16/17) means
that it is slightly more tax efficient to take
a gross salary to the tax free allowance
level (£11k for 16-17), however HMRC have
announced that from 16/17 the Employment
Allowance will not be available to companies
where the only person on the payroll is a
Director, i.e. ‘single director employee’ limited
companies.
Unfortunately, what they have left open as
a ‘grey’ area is the situation where there is
a husband and wife who are both directors
taking a salary with no other employees.
As things stand it would appear this would
be ok, however it is clear that HMRC’s
intention is to block companies that have
no ‘real’ employees from claiming the
employment allowance.
Our stand on this currently is to lean on the
cautious side and only take the employment
allowance if you are employing people other
than connected Directors.
So for a husband and wife only company we
would suggest to not claim the employment
allowance. Equally for contractors we would
therefore suggest not taking the employment
allowance.
We are hoping for clearer guidance to come
from HMRC at which point we may change
our position, however for now we are playing
it safe and it also keeps things a bit simpler.
With this in mind, we have outlined two
different salary and dividend options which
are put together on the basis that you wish
to stay below the higher tax band (£43k).
We have made some key assumptions when
preparing these calculations:
n No student loan balance
n Your only income is your salary and
dividends from your company
n You are not caught by IR35
n You have a standard personal allowance
n Your company has sufficient post tax
profits to support these dividends
Option 1 – claim the employment allowance
(if allowed), more tax efficient with a little more admin
Take an annual gross salary of £11,000 which
is the standard tax free personal allowance
for 16-17. Your personal allowance may be a
bit different if HMRC have adjusted your tax
code but to keep it simple we’ll assume the
standard £11,000.
This level of salary will not attract any personal
income tax, but it will attract some Employees
National Insurance which will total £355.20.
No Employers National Insurance will need
to be paid as it will be covered by the
Employment Allowance.
If you have other employees you will need to
consider if their salaries already use up the
£3k employment allowance, if they do then
you would be better going for Option 2 (see
next page). With regards to dividends, the
higher tax band is £43,000 so assuming you
want to stay in the basic tax band this leaves
you £32,000 of dividends to take. There will be
some personal tax to pay on these though, as
the first £5k is tax free but after that is charged
at 7.5% tax.
See below table for illustration:
16-17 Tax year
£ Annual
Gross Salary 11,000
Dividends 32,000
Total Gross Income 43,000
Employee NIC (355)
Tax on dividends (2,025)
Net cash in pocket 40,620
Any dividends taken above the higher tax
band will be taxed at 32.5% and even higher
if you trigger other tax tipping points such as
the child benefit charge at £50k, £100k tax
free allowance withdrawal and the upper tax
band at £150k.
4. Option 2 –
take a salary up to the NI Primary threshold
If you can’t claim the employment allowance
or want to keep things a little simpler this is a
good strategy for you.
There are two National Insurance thresholds
you need to be aware of:
n Lower Earnings Limit – as long as you
earn above this you are protecting your
entitlement to future state pension and
benefits, without necessarily paying any
National Insurance, leading us on to…
n Primary Threshold – if you earn above
this you have to start paying
National Insurance.
So the sweet-spot is to go up to the Primary
Threshold but no higher.
The National Insurance Primary Threshold for
16/17 remains the same as 15/16 at £155 per
week or £8,060 for the year.
Therefore we would suggest a monthly Gross
Salary of £670 which stays just below this
threshold.
With regards to dividends, assuming as with
Option 1 you wish to take dividends up to
the higher tax band but no further, then you
can take slightly more dividends with Option
2 than with Option 1. This is because you
are only taking just over £8k of salary which
leaves almost £3k of dividends that are in the
tax free allowance, as well as the £5k tax free
for the dividend allowance.
See below for how this works out with regards
to tax – it is the same tax amount but the
dividends are higher.
16-17 Tax year
£ Annual
Gross Salary (£670 x12) 8,040
Dividends 34,960
Total Gross Income 43,000
Employee NIC 0
Tax on dividends (2,025)
Net cash in pocket 40,975
You will note that the net cash in pocket after
income tax and employees NI is actually
slightly higher in Option 2 than 1 by £355,
however this doesn’t factor in the additional
corporation tax you save on the higher Gross
Salary in Option 1 .
See the summary section (opposite) for a
table which compares the two options side
by side and considers the corporation tax
effect as well.
Comparison
See below for a table which compares Options 1 and 2 and shows that overall
Option 1 is more tax efficient by £237.
16-17 Tax year
£ Annual
Option 1 Option 2
Gross Salary 11,000 8,040
Dividends 32,000 34,960
Total Gross Income 43,000 43,000
Employee NIC (355) 0
Tax on dividends (2,025) (2,025)
Net cash in pocket 40,620 40,975
Corporation Taxe saved on Gross Salary 2,200 1,608
Overall savings of Option 1 237
For contractors and freelancers, Option 2 is the recommended route and also has the added
benefit of being able to get a bit more personal cash in pocket despite costing a little more
corporation tax. Option 2 also has the added benefit of being less admin intensive as no
NI needs paying over to HMRC.
Tax planning ideas
Here are some tax planning ideas you might want to consider to help reduce the impact of the
dividend tax changes, these should be discussed with your accountant:
n Transfer a minority shareholding to your spouse so they can receive
up to £5k of dividend tax free.
n Set up a rental agreement with your company for claiming
‘use of home as office’ expenses.
n Company pension contributions
(speak to a pension advisor as various rules to consider).
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