Corporation tax rise – Salary VS Bonus, which is best?

2 days, 3 hours ago by Oliver Atkinson

The choice between a dividend or a bonus has always been an important decision from a tax standpoint. In recent years the difference has narrowed, however from April, the increase in the corporation tax rate to 25% from 19%, will mean that dividends may no longer have a superior advantage.

Dividends

Dividends are paid out of a company’s post tax profits; therefore it will not adjust the taxable profit of a company which are subject to corporation tax.

Previously, each individual has had a tax-free dividend allowance of £2,000 per tax year, this is decreasing to £1,000 for the 2023/24 tax year. The tax rates will remain the same at is 8.75% for the basic rate, 33.75% for the higher rate and 39.35% for the additional rate.

Bonuses

Companies are entitled to corporation tax relief for the bonus and National insurance contributions it has paid. Therefore, this means that bonuses can be used to offset against taxable profit to help reduce the
corporation tax bill.

Whilst this is beneficial to the company, for an individual it may not be the most tax efficient option. A taxpayer resident in England, Wales and Northern Ireland will be taxed at 20% for the basic rate, 40% for the higher rate and 45% for the additional rate.

Individuals are also subject to National insurance contributions which are 12% for earnings above £12,570 and up to £50,270, and 2% above £50,270.

The example below shows the difference in corporation tax and retained profit for the tax year 2023/24, if a bonus or dividend was taken out. For this example, the recipient will be taxed the full amount with the
higher rate band. If a company has profits of £300,000 with funds of £35,000 to pay out as a bonus or dividend. The company will be able to use the bonus and NIC to reduce their taxable profits and therefore their corporation tax is lower, and their retained earnings are higher.

However, looking at the tax implications for the individual, the dividend option is more tax efficient. A £35,000 dividend is taxed at a lower rate in comparison to the bonus, therefore the net receipts for a dividend is higher.

The example above illustrates some of the advantages of either method. With the proposed changes to corporation tax and dividend allowance going ahead for 2023/24 the difference has become narrower. it is important to note that depending on circumstances, the outcome may change.

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