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Basic instinct

For money that is to be extracted from a company for expenditure, the choice of dividend over salary is even easier for a basic-rate taxpayer than for a higher-rate taxpayer. The fact that not only employer&#39s but also employee&#39s NI contributions at 11 per cent will be due on salary is a significant reason for considering payment by way of dividend.

This is best illustrated by an example (below) showing the effective rates of deduction (combined income tax and NI) borne by higherand basic-rate taxpayers receiving dividends from companies paying respectively the small company, main and marginal rates of tax. The following assumptions are used:

i) £10,000 available to company before tax.

ii) 12.8 per cent employer NICs payable in all salary examples.

iii) 11 per cent employee NICs payable on salary only by 22 per cent taxpayers.

iv) 1 per cent employee NICs payable on salary over £30,940 only by 40 per cent taxpayers.

Despite the immediate attraction of dividends, in deciding how to extract funds from his company, the taxpayer must be aware of all the facts, including the impact that choosing dividends over salary can have on pension provision.

Dividends will be positively disadvantageous for non-taxpayers as they will be unable to reclaim the tax credit.

Where a given sum is available for extraction and it is established that the director does not need every £1 extracted for current expenditure, an effective presentation can sometimes be made demonstrating a lower rate of overall tax on extraction of funds for both the current and/or future benefit of the director.

Where the sum available could be paid into an occupational pension within current funding limits and based on current remuneration, the presentation should at least initially be founded on the premise that a direct employer contribution is made into a pension. This will facilitate maximum investment to provide for the director&#39s future security with no NIC/income tax depletion.

Where no further contribution can be made based on current salary, combining additional salary and pension can be attractive. Taking a higher-rate taxpayer aged around 50, if a company has £10,000 available pre-tax and for each extra £1 of salary a further £1 of pension contribution is to be made, the above will be the situation.

A bonus of £4,699 is paid. Net of 40 per cent income tax and the NIC surcharge of 1 per cent, this yields £2,772 although it generates employer&#39s NIC of £602. The salary payment enables a pension contribution of £4,699 to be made for the benefit of the director. Out of the £10,000 available pre-tax, the total amount working for the director is £7,471, which means the £10,000 has suffered an effective overall rate of tax of 25.29 per cent.

More than £7,400 is extracted for the director&#39s benefit – £4,699 directly into the pension with no depletion and available for personal investment.

Despite all this, it is reiterated that a careful consideration of the potential for creative planning with salary, dividends and DC pension contributions may well prove worthwhile.

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