Dividends V Bonuses – Which will save Tax?

After the Corporation Tax rate increased from 19% to 25% in April 2023, the longstanding preference for dividends over bonuses is up for debate.

This shift necessitates a deeper exploration into which form of profit distribution—dividends or bonuses—provides better tax efficiency under current tax regulations.

---

(Read Time: Approx. 4 minutes)

Topics Discussed:

• Detailed comparison of tax implications for dividends and bonuses.
• Impact of recent tax legislation changes on choosing between dividends and bonuses.

---

Understanding Dividends and Bonuses

Dividends are payments made to shareholders from the company’s post-tax profits and are not deductible from corporate profits.

This means they do not reduce the corporation tax liability of a company.

Conversely, bonuses are considered a direct business expense, thereby reducing the taxable profit of the company and potentially saving significant amounts in corporation tax.

---

Tax Treatment and Recent Legislative Changes

The tax changes for the year 2023-24 presents both challenges and opportunities in managing dividends and bonuses:

• Dividend Allowance: This was reduced to £1,000 from £2,000 in 2023, and as of the 6th of April 2024, has been reduced again to £500. The Tax rates are as follows:
  • 8.75% at the basic rate
  • 33.75% at the higher rate
  • 39.35% at the additional rate

• Bonuses: These are subject to income tax and National Insurance Contributions (NICs). The tax rates for bonuses are 20% at the basic rate, escalating to 40% and 45% for higher and additional rates, respectively.

---

Example:

Scenario-Based Tax Implications

Company Profits for Distribution: £500,000
Available Distribution Amount: £40,000

Bonus Scenario:

• Pre-Tax Bonus: £35,149
• Employer’s NICs (13.8%): £4,851
• Total Cost to Company (Bonus + NIC): £40,000
• Reduced Taxable Profits: £460,000
• Corporation Tax at 25%: £115,000
• Net Profit After Tax and Bonus: £345,000

Dividend Scenario:

• Dividend Pay-out: £30,000
• Taxable Profits: £500,000 (no reduction for dividends)
• Corporation Tax at 25%: £125,000
• Net Profit After Tax and Dividend: £375,000
• Adjusted Retained Profit: £345,000

Individual Tax Liabilities:

• Net Take-Home from Bonus: £20,386, after accounting for 40% income tax and 2% NIC.

• Net Take-Home from Dividend: £20,213, after dividend tax exceeding the reduced allowance.

This analysis illustrates that the bonus now provides a slightly higher net take-home amount than the dividend by £173, which is a significant shift influenced by the increased corporation tax rate.

---

Strategic Considerations for Tax planning

Bonuses might now offer more substantial cash flow benefits due to their deductibility, which could be good for businesses aiming for immediate tax relief.

Furthermore, the timing of these distributions and the company’s overall profit play pivotal roles in determining the most tax-efficient choice.

---

The Future and Recommendations

As the tax legislation changes, businesses must remain flexible, continuously reviewing their tax strategies to ensure alignment with current tax legislation.

Given the complexities introduced by the new tax regime, it’s essential for business owners and tax planners to reassess the most beneficial method for profit distribution.

Decisions between dividends and bonuses should now be based on detailed tax analysis to optimise tax efficiency and align with strategic business goals.

In light of these changes, businesses might consider conducting regular tax reviews to adapt to the ongoing shifts in the environment.

These reviews can help in strategising the distribution of profits and in planning for future investments and understanding the broader tax implications of changes on business operations.

---

Summary

Navigating the tax implications of dividends versus bonuses requires careful consideration and strategic planning.

If you’re navigating these decisions considering the latest tax changes or need assistance with any aspect of your yearly tax planning, consider partnering with us at Tax Expert.

At Tax Expert, we are equipped to provide you with tailored advice that addresses your unique tax circumstances and helps you maximise your tax advantages.

Contact Tax Expert today – our team stands ready to guide you through these changes with strategic advice and detailed tax planning to ensure that your business remains compliant and optimised for the evolving tax environment.

Let us help you make the most informed decisions to benefit your business’s financial future.

---

Contact us today at 01772 788200 to find out more about how we can help, or WhatsApp us out-of-hours at 07787 010190.

---

Kind regards,

Ilyas Patel