Autumn Statement: Bonuses better than dividends – which one wins?

So what does the third Budget of the year have in store for business owners?  Is it ‘third time lucky, or 5/10 ‘could do better?’

The main consideration for many of our clients will be what effect does the Budget have on their ability to extract profits from their business?

Key points applicable to owner-managers

The position on profit extraction for owner-managers from April 2023 is as follows:

• The additional rate of Income Tax now applies to income above £125,140 (45% tax rate for most income and 39.35% for dividend income).
• The main rate of Corporation Tax rises to 25% from 1 April 2023 with a Small Companies rate of 19% on profits up to £50,000.
• All other taxes remain at their rates and thresholds as for the current tax year (2022/23)

What does this mean from 6 April 2023?

Historically dividends have been a more tax efficient remuneration option than bonuses, particularly for those taxpayers with income in the higher and additional rate bands. However, the combined impact of the rate changes above means that the effective tax rates for dividends versus bonuses are expected to become broadly the same across each of the income tax bands.

Looking at the position for an additional-rate taxpayer (i.e. those with incomes over £125,140 in 2023/24 or over £150,000 in 2022/23), the overall effective tax rate on surplus profits extracted is 51% for dividends versus 55% for bonuses.

As illustrated below, this differential is removed with effect from 6 April 2023 when the overall effective rate for an additional rate taxpayer becomes 55%, whether the profit is extracted as a dividend or as a bonus.

There are, of course, other factors which should be taken into consideration as part of an owner-manager’s remuneration strategy, including:

• For companies making R&D claims, it may be beneficial for the owner-manager to take an increased salary in order to maximise the R&D tax credit claim and, in turn, reduce their overall effective tax rate.
• The timing of the tax payable will be different. Tax on a bonus is paid under PAYE and so is payable at the time whereas income tax on a dividend is paid on 31 January/July but will impact on payments on account. Many clients may prefer the simplicity of payment through PAYE.
• Those owner managers over state retirement age are not liable to pay Employees National Insurance (NIC) and so will be better off taking a bonus.
• There may be a benefit in taking a salary/bonus in terms of state benefits, or schemes such as furlough, but also for pension contribution purposes as well as mortgage or other loan applications etc.
• Pension contributions remain the most tax efficient way to extract profits from a company for an owner-manager, assuming that you don’t need the money right now. Particularly for those in their late 40s or early 50s, it might be worth re-visiting what pension planning opportunities there are – especially if a pension contribution and loan back to the company is possible. Given the increase in the Corporation Tax rate then pension planning may be a good option.
• Other ideas include Relevant Life Policies, or tax efficient benefits in kind, especially where an existing family cost such as life assurance, can be replaced by a cost which is borne by the company and on which tax relief is achieved.

All in all it is quite a big sea change, but the difference in most tax liabilities is likely to be fairly small. That said, it is worth reviewing the profit extraction strategy used over the coming year.

Capital Gains Tax (CGT) continues to be payable at much lower rates currently and so business owners may wish to explore whether or not it is attractive for them to extract value from their company as a capital receipt – perhaps as a sale, but otherwise maybe as part of a family succession arrangement.

Pre-tax year end planning opportunity

The figures in the table assume that the owner is wholly within the additional rate. But what if the annual income the owner manager is taking currently falls between £125,140 and £150,000, such that they will be pushed into the additional rate next year but could have some unused higher rate tax band this year.

What if your current annual income is £140,000? By taking a further dividend of £10,000 in 2022/23 and reducing the dividend taken in 2023/24 by £10,000 then it would be possible to save tax of £560, albeit accelerating the payment of the tax by 12 months. If this applied to a couple then there is an attractive one-off opportunity to try and accelerate some income and save tax. The Government expects this, which is why the tax take from this new measure is lower in the first year.

As these figures demonstrate, for the first time in a long time, it may be better to pay bonuses from April 2023 rather than taking dividends. For some time now the Government has been trying to level the playing field between employees and business owners, and it seems that with these changes they might be nearly there.

For more analysis, visit our Autumn Statement hub.