As of the new tax year, income tax has increased on dividends (and from next April tax on savings and rental income will also be increasing). This has prompted us to re-issue our blog on taking salary vs dividends, as we’re sure many business owners will be reconsidering whether it’s still worth taking dividends.
Firstly, we will recap where we currently stand with the main taxes involved before we get to a comparison of salary versus dividends and possible remuneration strategies.
Income Tax
The main rates for earned income will remain at 20% (basic), 40% (higher) and 45% (additional).
As of April 6th, basic rate income tax on dividends has increased from 8.75% to 10.75% and the higher rate from 33.75% to 35.75%. The additional rate isn’t increasing, remaining at 39.35%, because of reasons.
The Personal Allowance, up to which you don’t pay income tax, remains at £12,570 and the basic rate tax band at £37,700. Both are now frozen until 2031 (a full decade at these levels).
The point at which you begin losing your personal allowance remains at £100k – as it has since 2010. For every £2 your income exceeds £100k, your personal allowance will be reduced by £1 until it is entirely lost. This creates very high effective rates of tax on earnings between £100k and £125,140.
The point at which you pay additional rate tax (45%) remains at £125,140 of income (about £25k lower than in 2010!).
The dividend allowance remains at £500.
National Insurance
As we are all too aware, the 2024 Autumn Budget increased Employer National Insurance Contribution (NICs) rates to 15%. Controversially, it heavily decreased the point at which you begin paying these (the “secondary threshold”) to just £5,000 of salary.
The point at which you start paying personal / employee NICs (the “primary threshold”) has remained at £12,570 – the same point at which you begin paying income tax. Employee NICs are 8% on earnings between this level and £50,270 (the “upper earnings limit”) and 2% above this.
Employment Allowance
If your business has more than one employee (including directors) paying NICs (i.e. earning more than £5k) you will normally be entitled to an allowance covering the first £10,500 of employer NICs in a tax year.
Where a firm has multiple employees, this will be utilised regardless and can essentially be disregarded in business owner remuneration planning. However, where you have a firm with only two business owner directors as employees e.g. a husband and wife run firm, you could factor in the employment allowance, choosing to take combined salaries sufficient to maximise the employment allowance e.g. £40,000 each for two owners.
Corporation Tax
The main rate of Corporation Tax was increased to 25% in April 2023. A small profits rate lowers this to 19% for companies with profits of less than £50,000.
For companies with profits of between £50,000 and £250,000 a ‘marginal relief’ will apply, meaning the full 25% rate comes in gradually between these levels.
Salary vs Dividends – marginal effective tax rates
Over recent years, increases in dividend taxation and corporation tax have eroded (and to an extent reversed) the tax advantage of taking dividends compared to salary / bonus. The new 2% increase in dividend income tax continues this trend.
The table below shows the effective rates of tax on a business owner drawing £1 of trading profit personally. The rates are at the margin, on each additional £1 drawn within the respective tax bands. It includes the impact of Income Tax, NICs (personal and employer) and Corporation Tax. The rates are those applicable above the primary threshold and dividend allowance (assuming these are drawn first) and ignore the employment allowance. Dividends are considered for the small company (19%) and main (25%) rates of Corporation Tax:
| Marginal Effective Rates of Tax Above Primary Threshold | |||
| Tax Band | |||
| Basic | Higher | Additional | |
| Salary / Bonus | 37.4% | 49.6% | 53.9% |
| Dividend (small co. CT rate) | 27.7% | 48.0% | 50.9% |
| Dividend (main CT rate) | 33.1% | 51.8% | 54.5% |
Important note: the above table considers the three listed taxes only and is based on drawing current year trading profits. It doesn’t consider any other sources of personal income and doesn’t include the potential loss of any benefits or allowances as the result of increased income.
The effective rate of tax is greater on dividends at higher and additional rates, where the company pays the main rate of corporation tax. Dividends remain more tax efficient at the basic rate however, although this difference is no longer that large for companies paying the main rate of corporation tax.
For many small business owners however, it will remain broadly attractive to continue taking dividends to enjoy that advantage at the basic rate. N.B. dividends are taxed after other income, so you can’t have dividends taxed at basic rate and salary at higher.
Part of this reason is that because a large proportion of the tax burden sits within the company (Corporation Tax), rather than the individual, more personal net income can be drawn before hitting higher rates of tax.
Remuneration Planning 2026/27
For a business owner-manager drawing a salary, the first £5,000 will be completely tax free. Salaries are deductible for Corporation Tax and the amount is below the thresholds for income tax and employer and employee NICs.
Salary above £5,000 will attract employer NICs at 15%. Earnings over £12,570, will incur both personal (8%) and employer NICs.
For most, it will make sense to draw a salary of £12,570 in 2026/27 – the personal allowance for income tax and point at which you start paying personal NICs. This will involve paying some employer NICs (on salary between £5,000 and £12,570), however employer NICs are lower than corporation tax (for which dividends aren’t deductible).
Above this amount it will usually be more tax efficient to pay dividends, rather than salary. As the above table shows, the effective rate of tax on drawing dividends at basic rate tax is lower than for salary/bonus.
Once earnings exceed the basic rate, the tax on dividends increases sharply. The basic rate tax band is £37,700, meaning that income can total £50,270 before higher rate tax is incurred (i.e. £37,700 plus the £12,570 personal allowance).
It will also be worth keeping in mind the loss of personal allowance on (total) income over £100k; due to the high effective rates of tax on income between £100k and £125,170.
Below are two examples of a remuneration plan for a business owner drawing a salary of £12,570 and dividends above this. We have assumed that the business makes a profit of over £250k after director remuneration, meaning the main (25%) rate of corporation tax applies:
Example of business owner drawings within basic rate*:
Example of business owner drawings to retain personal allowance*:
* Assuming no other income
Of course, if a husband and wife jointly own and run a business, the above would apply to each. With a 50-50 owned business, c. £128k of trading profits could be used to provide a net income of c. £92k (£46k each) or c. £260k of trading profits could be used to provide a net income of £156k (£78k each).
Employer Pension Contributions
Pension contributions can be very effective for tax-efficient profit extraction, particularly where a business owner is already drawing £100k of income. By making employer pension contributions, funds can be moved into your personal name with no initial tax liability (either personally or on the company1).
Income tax would be incurred when funds are ultimately drawn from a pension, however a.) currently 25% of a pension can be drawn tax-free and b.) income often drops in retirement, meaning income tax incurred is often lower than that avoided on making the contribution.
You may have heard pensions are due to fall within the scope of Inheritance Tax (IHT) from April 2027, however this doesn’t remove the above noted tax advantages. This subject is discussed in greater detail in this blog.
Electric Company Cars
Zero emission company cars currently benefit from a generous tax regime (and conventional petrol and diesel cars a terrible one).
For the 2026/27 tax year, the Benefit in Kind (BIK) rate is just 4% of the list price (rising to 5% and 7% over 27/28 and 28/29), meaning if your company provided you with a £50k electric company car, you would be assessed as only having an extra £2k of taxable earnings. The company can also pay for other costs (insurance, service and maintenance, tax etc) within this treatment.
From the company’s perspective, 100% of the cost of purchasing a new electric car can be claimed against profits for purchases up to 31st March 2027. If the company leases a car, this cost is usually deductible. If the car is required for business use, half of the VAT on the lease can also normally be reclaimed.
This can make your company providing you with an electric car, rather than you personally buying/leasing a car out of net income a tax efficient option.
Further Help
If you would like to further discuss remuneration and profit extraction from your business, please do get in touch and we will see if we can help.
1 assuming the contribution can be justified as part of the remuneration package, which is usually the case for business owner-directors.
Disclaimer
The above is provided for general information only. No action should be taken without seeking advice for your specific circumstances. Collingbourne Wealth Management Ltd does not provide tax advice. All information is based on our understanding of current tax rules as at the time of writing, which are subject to change.