Whether to set up as a limited company, and then whether to pay dividends or salaries has long been an area where people have looked to their accountant for advice. With the tax rules that are currently in place many businesses have chosen to incorporate and pay dividends as well as salary to the owners.
The changes announced by George Osborne for 2016/17 will change the calculation for this, but not necessarily the decision. In many cases you will still be better off as a limited company, but less so than you used to be.
Let’s look at how things work now in 2015/16 for 3 sisters, Sally, Diva and Selena who all have identical businesses which make £35,000 profit per year, and they have no other income:
Sally has a limited company and wants to use the £35,000 to take the maximum salary she possibly can. This results in her receiving £24,670 after tax and national insurance.
Diva has a limited company, takes a salary of £10,600 and as much dividend as she can out of the remaining profits. This gives her £29,540 after tax and NI – so she is better off by £4,870 compared to her sister Sally.
Selena is self-employed and once she has paid tax and NI she takes home £27,550 – an increase of £2,880 compared to Sally.
In this situation Sally and Selena would be better off paying a mixture of dividends and salary through a limited company.
In 2016/17 a new tax of 7.5% will be payable on dividends up to £32,000 per annum (there are higher tax rates of 32.5% and 38.1% for higher levels of dividend).
In the example above, Diva would pay an extra £1,229 in tax on her dividends under the new rule, so she will be worse off. However, it still leaves her £3,641 better off than someone just taking a salary and £761 better off than if she had been self-employed.
There are many things that can complicate the calculation (and change the decision) such as other income, other taxable benefits, size of profits, extra costs of incorporation, how many people are involved in the business etc. – so it is best to take specific advice based on your individual circumstances.