Salary and Dividends 2022-23
For now, we are only considering extracting profits as salary and/or dividends. Note that when we talk about withdrawing profits from the company, it is easy to assume this will be in cash.
This is not necessarily the case. The year-end profits could be represented by cash at the bank, but it is not necessary to pay out cash to withdraw profits.
Salary or dividends can also be paid by crediting them to the director’s loan account (DLA). This is still a taxable event, and effectively gives the director shareholder an IOU that can be drawn against later on with no further tax consequences.
Note. For the sake of simplicity, we have assumed that in all our examples the individual is only entitled to the personal allowance, i.e. there are no other reliefs or allowances to be considered. This may not be the case in practice.
Optimal position
It’s important to understand that there is no one right answer, as it will depend on each individual’s circumstances. For example, there will be no merit in a director taking a salary if they have other income exceeding their personal allowance. There will also be differences in strategy in situations where the EA is available, e.g. where two spouses or civil partners are running a business through a company together. Additionally, it’s an easy trap to work on the basis that all available profits have to be taken out of the company each year. Whilst this may be the initial mindset of the director shareholders, it may not be necessary and significant savings can sometimes be made by restricting profit extraction. In many cases, when a director shareholder asks, “what is the optimum profit extraction strategy?” what they are really looking for is advice on what level to set the salary at. This is particularly true for those looking to extract all the profits, and usually the remaining amounts will be taken as a dividend, either in cash or as a credit to the DLA. So, what’s the story for 2022/23? The answer will depend on whether the director has other income, and if the EA is available.
Single person company and no other income
In this situation, the EA isn’t available. This means that any salary above £9,100 will attract employers’ NI at 14.53%. However, because the salary is deductible for CT purposes there is a saving of 19%. In previous years, the benefit of this has usually been overshadowed by employees’ NI, the optimum position for a director with no other income, and that has no entitlement to reliefs or allowances other than the personal allowance, has usually been to restrict the salary to the level of the ST. However, as the PT and ST are now so far apart, we need to reconsider. Let’s look at a simple example of a company with profits of £60,000 where the single director shareholder wants to extract all the profits and is looking to optimise the salary level.
There are three obvious options, i.e. a salary equal to: • the ST, £9,100 • the annual directors’ PT, £11,908 • the personal allowance, £12,570.
If all profits are to be extracted, the total tax and NI in each situation will be as follows:
If all profits are to be extracted, the total tax and NI in each situation will be as follows:
| Salary | £9,100 | £11,908 | £12,570 |
|---|---|---|---|
| Employee’s NI | £0 | £0 | (£84) |
| Employer’s NI | £0 | (£408) | (£504) |
| CT payable | (£9,671) | (£9,060) | (£8,916) |
| Dividend | £41,229 | £38,624 | £37,974 |
| Income tax | (£3,144) | (£3,124) | (£3,216) |
| Total tax/NI | £12,815 | £12,592 | £12,720 |
So, for a single person company where the EA isn’t available, and the personal allowance is available in full, the optimum position will be a salary of £11,908. The saving compared to the next best option is relatively modest though.
Employment allowance is available
Let’s suppose the same company has another employee who is paid above the PT during the tax year. The EA will now offset the employers’ NI and the results will be as follows:
| Salary | £9,100 | £11,908 | £12,570 |
|---|---|---|---|
| Employees’ NI | £0 | £0 | (£84) |
| Employers’ NI | £0 | £0 | £0 |
| CT payable | (£9,671) | (£9,137) | (£9,012) |
| Dividend | £41,229 | £38,955 | £38,418 |
| Income tax | (£3,144) | (£3,324) | (£3,366) |
| Total tax/NI | £12,815 | £12,461 | £12,462 |
So, where the EA is available there is virtually no difference between a salary of £11,908 and one of £12,570 in terms of overall tax and NI.
Director has other income and only entitled to personal allowance
Whether the other income affects the profit extraction salary will depend what the income consists of. Let’s assume we are looking at a single director shareholder company with profits of £60,000 where no EA is available. The director has £5,000 of rental profits. Can they save tax by altering their profit extraction strategy?
If they opt for the same mix of salary and dividends as before, their tax calculation will look like this:
If they opt for the same mix of salary and dividends as before, their tax calculation will look like this:
| Salary | £11,908 |
| Rental profits | £5,000 |
| Dividends | £38,624 |
| Taxable income | £55,520 |
| Income tax | (£5,388) |
| Employers’ NI | (£408) |
| Total tax/NI | (£5,796) |
| In-pocket | £49,724 |
However, if they restrict the salary to ensure that the salary and rental profits are covered by the personal allowance, the position is as follows:
| Salary | £7,570 |
| Rental profits | £5,000 |
| Dividends | £42,468 |
| Taxable income | £55,038 |
| Income tax | (£4,733) |
| Employers’ NI | £0 |
| Total tax/NI | (£4,733) |
| In-pocket | £50,305 |
That’s almost £600 better in terms of the in-pocket position just by changing the mix of salary and dividends, and underlines why each director shareholder needs to take more than just the company profits into account when looking at profit extraction planning.
All income
Not all other sources of money will mean an adjustment to the extraction strategy. Capital gains are not subject to income tax and so will have no effect on income planning. However, beware gains on things like investment bonds which are classed as “income gains”.
If the rental income qualified for rent-a-room relief, which means an individual can receive up to £7,500 per year for renting part of their main home, e.g. to a lodger, no adjustment would be needed.
Investment interest can be tax free – up to £6,000 in the right circumstances – owing to two savings allowances. It’s worth keeping in mind that unless the other income is subject to income tax or affects the use of the personal allowance, it will have no effect on the extraction strategy. So, if income is exempt it can be ignored. This will include things like:
If the rental income qualified for rent-a-room relief, which means an individual can receive up to £7,500 per year for renting part of their main home, e.g. to a lodger, no adjustment would be needed.
Investment interest can be tax free – up to £6,000 in the right circumstances – owing to two savings allowances. It’s worth keeping in mind that unless the other income is subject to income tax or affects the use of the personal allowance, it will have no effect on the extraction strategy. So, if income is exempt it can be ignored. This will include things like:
- Dividends from venture capital trust investments
- interest and dividends from ISAs where the investment limits have been adhered to
- exempt lump sum payments from pension funds.
Profits much higher
Above a certain level of income the personal allowance of £12,570 is abated. It is reduced by £1 for every £2 your taxable income exceeds £100,000.
Example John’s taxable income for 2022/23 is £110,000. His personal allowance is abated by £10,000/2 = £5,000, leaving him with £7,570.
Above £125,140, there will be no personal allowance at all. The marginal tax rate where the income falls between £100,000 and £125,140 is 60% if it is subject to the main income tax rates (it will be slightly lower for dividends). This is because tax is payable on income that was previously covered by the lost allowance. It’s effectively 20% on the excess income over £100,000 as the abatement rate is at £1 for every £2 of excess, i.e. only half of the excess is actually subject to additional tax.
Example In John’s example above, the excess £10,000 means a loss of £5,000 of the personal allowance. This will mean the £5,000 will be subject to tax at 40%, in addition to the £10,000 (which already falls into the higher rate tax band). This gives an effective rate of 60%.
Our recommendation is to try to avoid falling into this marginal rate at all costs. If the company profits are such that extracting everything would mean your taxable income is above £100,000, there will be no point in taking a salary as there will be no personal allowance to offset it, and a salary will be subject to higher rates of tax than dividends. Of course, the dividends won’t be deductible for CT purposes, but this advice still holds.
Example John’s taxable income for 2022/23 is £110,000. His personal allowance is abated by £10,000/2 = £5,000, leaving him with £7,570.
Above £125,140, there will be no personal allowance at all. The marginal tax rate where the income falls between £100,000 and £125,140 is 60% if it is subject to the main income tax rates (it will be slightly lower for dividends). This is because tax is payable on income that was previously covered by the lost allowance. It’s effectively 20% on the excess income over £100,000 as the abatement rate is at £1 for every £2 of excess, i.e. only half of the excess is actually subject to additional tax.
Example In John’s example above, the excess £10,000 means a loss of £5,000 of the personal allowance. This will mean the £5,000 will be subject to tax at 40%, in addition to the £10,000 (which already falls into the higher rate tax band). This gives an effective rate of 60%.
Our recommendation is to try to avoid falling into this marginal rate at all costs. If the company profits are such that extracting everything would mean your taxable income is above £100,000, there will be no point in taking a salary as there will be no personal allowance to offset it, and a salary will be subject to higher rates of tax than dividends. Of course, the dividends won’t be deductible for CT purposes, but this advice still holds.
Worked illustration
Consider two contrasting profit extraction strategies for a single director company with profits of £250,000. The first (strategy A) assumes that the director chooses to take a salary of £11,908, and the rest of the after-tax profits as dividends. The second (strategy B) assumes that the director receives no salary and takes all of the profits out of the company as dividends. The contrasting positions in the company will be as follows:
| Strategy A | Strategy B | |
|---|---|---|
| Pre-tax profits | £250,000 | £250,000 |
| Salary | (£11,908) | 0 |
| Employer’s NI | (£408) | 0 |
| Profits chargeable to CT | £237,684 | £250,000 |
| CT payable | (£45,160) | (£47,500) |
| Available as a dividend | £192,524 | £202,500 |
The two contrasting personal tax calculations will then be as follows:
| Strategy A | Strategy B | |
|---|---|---|
| Salary | £11,908 | 0 |
| Dividend | £192,524 | £202,500 |
| Total | £204,432 | £202,500 |
| Tax on salary at 20% (£11,908 x 20%) | (£2,382) | 0 |
| Tax at dividend basic rate | (£2,082) | (£3,124) |
| Tax at higher dividend rate | (£37,901) | (£37,901) |
| Tax at additional dividend rate | (£21,419) | (£20,659) |
| Income after tax | £140,648 | £140,816 |
So, strategy B is the better option, albeit only by a modest amount.
An awkward position will arise if the company profits are at a level where a full withdrawal would mean your taxable income would fall into the abatement range, i.e. between £100,000 and £125,140. The optimum salary level here would be restricted to the remaining personal allowance, with the remainder taken as dividends. The problem is you need to know what the remaining personal allowance is in order to set the salary level. To work out the personal allowance, you need to know the total taxable income, which means you need to know the salary level to work out the optimum salary level.
It may be possible to set up a complex spreadsheet to work this out, or to plot a graph to help approximate the best position. However, this is a lot of work for a relatively small amount of savings. There are far easier ways of maintaining efficiency here, and we will look at these in the next section.
An awkward position will arise if the company profits are at a level where a full withdrawal would mean your taxable income would fall into the abatement range, i.e. between £100,000 and £125,140. The optimum salary level here would be restricted to the remaining personal allowance, with the remainder taken as dividends. The problem is you need to know what the remaining personal allowance is in order to set the salary level. To work out the personal allowance, you need to know the total taxable income, which means you need to know the salary level to work out the optimum salary level.
It may be possible to set up a complex spreadsheet to work this out, or to plot a graph to help approximate the best position. However, this is a lot of work for a relatively small amount of savings. There are far easier ways of maintaining efficiency here, and we will look at these in the next section.
Undrawn profits
Remember, you could pay the equivalent of 60% tax on up to £25,140 of income where your taxable income falls between £100,000 and £125,140. Leaving profits undrawn is one way of avoiding this.
This stems from the fact that when you draw profits as a dividend, it is effectively taxed twice – once in the hands of the company as profits, and once in your hands as dividend income. Because you can control the timing of dividends, you can spread the tax bill across a number of tax years. This can be sensible in any case, as it provides a safety net for future years in case of unforeseen events that could adversely affect profits, such as the pandemic.
Example 1 Lilith operates her business through a company and has always extracted all profits using a mix of a low salary and topping up with dividends. In 2022/23, there is a particularly good year, and her profits have increased to £140,000 (they are usually between £100,000 and £120,000). If she adopts her usual strategy and sets the salary at £11,908, the position with full extraction would be as follows:
This stems from the fact that when you draw profits as a dividend, it is effectively taxed twice – once in the hands of the company as profits, and once in your hands as dividend income. Because you can control the timing of dividends, you can spread the tax bill across a number of tax years. This can be sensible in any case, as it provides a safety net for future years in case of unforeseen events that could adversely affect profits, such as the pandemic.
Example 1 Lilith operates her business through a company and has always extracted all profits using a mix of a low salary and topping up with dividends. In 2022/23, there is a particularly good year, and her profits have increased to £140,000 (they are usually between £100,000 and £120,000). If she adopts her usual strategy and sets the salary at £11,908, the position with full extraction would be as follows:
Company
| Pre-tax profits | £140,000 |
| Salary | (£11,908) |
| Employer’s NI | (£408) |
| Profits chargeable to CT | £127,684 |
| CT payable | (£24,260) |
| Available as a dividend | £103,424 |
Lilith
| Salary | £11,908 |
| Dividend | £103,424 |
| Total | £115,332 |
| Personal allowance | £4,904 |
| Tax on salary | (£1,401) |
| Tax at dividend basic rate | (£2,511) |
| Tax at higher dividend rate | (£24,546) |
| Income after tax | £86,874 |
Here, there are no profits left in the company. However, if Lilith were to restrict the dividend to just enough to make her total income £100,000, there would be £15,320 in undrawn profits. Her personal position would be:
| Salary | £11,908 |
| Dividend | £88,092 |
| Total | £100,000 |
| Personal allowance | £12,570 |
| Tax on salary | £0 |
| Tax at dividend basic rate | (£3,124) |
| Tax at higher dividend rate | (£16,784) |
| Income after tax | £80,092 |
Her after-tax income reduces by £6,782. Now, let’s suppose 2023/24 is a particularly bad year for the company, and after applying her strategy Lilith has taxable income of £80,000. She can now extract the undrawn profits from the previous year. These will be taxed at 33.75%, leaving her with an extra £10,150 in after-tax income. Delaying taking the profits has therefore saved her £10,150 – £6,782 = £3,368 over the course of the two years.
Depending on what the long-term plans are, a director could leave undrawn profits in the company for many years, accumulating a fund that can help boost retirement income, when the dividends are likely to be lower.
Example 2 Let’s assume that Lilith has similar results for another 14 years. She adopts a profit extraction strategy to ensure she doesn’t fall into the personal allowance abatement range, i.e. restricting the combined salary and dividends to £100,000, leaving around £15,000 of undrawn profit in each of those years. Lilith then retires upon attaining state retirement pension age. She receives £11,000 per year initially. She also has a private annuity paying an additional £21,000. Assuming the personal allowance and basic rate band remains the same, these amounts would leave scope to withdraw £18,270 of the undrawn company profits as a dividend. Again, assuming the dividend tax rates don’t change, these will only be subject to tax at 8.75%. The accumulated profits, ignoring any interest or income from company investments using the funds, would be just short of £230,000 – enough to adopt this strategy for almost 13 more years.
Of course, the undrawn profits could be invested by the company to generate capital growth, meaning that Lilith’s company piggy bank could be considerably fatter by the time she reaches retirement. There are also other things she could do with the undrawn profits, and we’ll take a look at some of these in the next section.
Depending on what the long-term plans are, a director could leave undrawn profits in the company for many years, accumulating a fund that can help boost retirement income, when the dividends are likely to be lower.
Example 2 Let’s assume that Lilith has similar results for another 14 years. She adopts a profit extraction strategy to ensure she doesn’t fall into the personal allowance abatement range, i.e. restricting the combined salary and dividends to £100,000, leaving around £15,000 of undrawn profit in each of those years. Lilith then retires upon attaining state retirement pension age. She receives £11,000 per year initially. She also has a private annuity paying an additional £21,000. Assuming the personal allowance and basic rate band remains the same, these amounts would leave scope to withdraw £18,270 of the undrawn company profits as a dividend. Again, assuming the dividend tax rates don’t change, these will only be subject to tax at 8.75%. The accumulated profits, ignoring any interest or income from company investments using the funds, would be just short of £230,000 – enough to adopt this strategy for almost 13 more years.
Of course, the undrawn profits could be invested by the company to generate capital growth, meaning that Lilith’s company piggy bank could be considerably fatter by the time she reaches retirement. There are also other things she could do with the undrawn profits, and we’ll take a look at some of these in the next section.