Go Back

22/05/23

How does the Corporation Tax rise to 25% and the reduction in the tax-free dividend allowance from April 2023 affect business owners’ ability to extract profits from their companies?

In most cases in recent years, it has been more tax efficient to take a dividend than pay a bonus. However, the tax changes which came into effect from April 2023 may mean this is no longer the case.

Key tax changes to tax rates and allowances

The main rate of Corporation Tax increased to 25% from 1 April 2023 but the 19% rate has remained for companies with profits of less than £50,000. A taper mechanism applies when profits are between £50,000 and £250,000.

The additional rate of Income Tax (45% tax rate for most income and 39.35% for dividend income) now applies to income above £125,140 in 2023/24 (£150,000 in 2022/23).

The tax-free dividend allowance for 2023/24 is £1,000, a reduction from £2,000. The basic rate of tax on dividends is 8.75%, the higher rate 33.75% and the additional rate 39.35%.

Dividends

Dividends are paid out of a company’s post-tax profits and are not deducted from profits in calculating a company’s Corporation Tax liability. Individuals pay Income Tax on dividends received through self-assessment.

Bonuses

Individuals pay Income Tax and National Insurance contributions on bonuses. The basic rate tax of 20% is paid on income between £12,570 and £50,270, the higher rate of 40% is paid on income above £50,270, and the additional rate of 45% is paid on income above £125,140.

National Insurance contributions are 12% for Employee contributions on earnings between £12,570 and £50,270 and 2% for earnings over £50,270, and 13.8% for Employer contributions on earnings above £9,100.

Which option is most tax efficient?

Let’s look at a worked example. Please note that every situation will be different depending on the company’s taxable profits and the recipient’s tax position. It is therefore essential to seek advice, as each taxpayer’s case is different.

Let’s assume a company has profits before tax of £300,000 for the year and sufficient funds to extract profits, so that it ends up with retained profits of £202,500. Let’s further assume the recipient will pay tax on the bonus or dividend at the additional rate of Income Tax and that the £1,000 tax free allowance has already been utilised.

As shown below, if a bonus is paid, the recipient would receive £13,972 after Income Tax and NIC, as compared to if a dividend is paid, the recipient would only receive £13,646, i.e. £326 less.

There are other considerations when making the calculation, such as the timing of tax payments and the advantages of making pension contributions, but the key takeaway is, that as a result of the changes to income tax and corporation tax rates, the assumption that a dividend is more tax efficient than a bonus is not necessarily true anymore.

The income tax bands and rates quoted will be different if you are a Scottish tax payer.

The above is general advice concerning the payment of dividends and bonuses. If you have any queries about this topic, please contact Joel Calitchi: joel.calitchi@mgr.co.uk

Warning: The above is merely general guidance and should not be relied upon as formal advice. The advice we give to each client will depend on their specific circumstances. We suggest you take professional advice before taking any action in relation to the issues discussed above.

You can find more of the latest accounting updates here.