Hi all, I am curious about dividend payment structure in a limited company. I wonder if anyone can help.
Hypothetical scenario:
A limited company has a director who is the sole employee. They draw a salary £9,100pa at the NI secondary threshold so that there are no NI obligations.
The director can take a further £5,470 in dividends before incurring personal tax (£3,470 to use up to the personal allowance plus £2,000 dividend allowance).
The director now has an income of £14,570pa.
The company has paid 19% tax on the underlying profit that the dividends are paid from. It would need £6,753 of income to enable a dividend payment of £5,470.
So, the company needs an income of £15,853 to pay the director this £14,570, with a total tax paid of £1,283.
If the director were a sole trader instead, and had earned £15,853, they would pay 0.2*(£15,853-£12,570) = £657 tax on this income.
Now on any further dividend income the director wishes to take, they will pay at least 8.75% tax. This is after the company paying 19% on the profit. As a sole trader, they would pay 20% at basic rate (albeit without the £2,000 dividend allowance).
I know this is supposedly a tax-efficient system, but I am failing to see the benefit here. Obviously, they would take the NI efficiency into account; is this really the only efficiency in limited vs sole?
Replies (18)
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I doubt many people would advise somebody earning £15,000 to set up as a limited company as the benefit is minimal if anything. (Without taking into account personal circumstances etc)
I must be missing something obvious, but I don't see the tax benefit purely in those terms.
National Insurance?? Your calculations should be...
20% + 9% + £3 p/w = 29% + £3 p/w
vs
19% + 8.75% = 27.75%
I agree with you that the gap between Ltd v S/T has significantly narrowed in the last few years.
"Thanks, yes that confirms my thought that NI is the only real benefit"
There are other benefits - eg extra tax/ni relief on pension contributions can be a saver - avoiding paying 10% ni on profits syphoned into pension compoared to sole trader.
The main elephant in the room on top of the useful marginal saving is the saving once you start to bubble on the higehr rate tax band - even then though the tax planning is complex as higher rate taxpayers can end up with higher marginal rate via company structure.
not 27.75%
the dividend tax is calculated after tax, so is 8.75% of 81% on net profit
Hence it is 19% +7.1% = 26.1%
Percentages need to be of the correct start point
As Alex has said (albeit slightly incorrectly given the current rate of Class 4 NIC is 10.25% for SE) you are forgetting NI! This is so often overlooked but, it is a TAX on income. You should also remember in the current year NIC for self-employed 'kicks in' at £9,881, so the 10.25% is payable on £2,689 more income than tax.
There are, however, many more reasons to consider incorporation! Tax efficiency should only ever be one reason and should NEVER be the sole motivation!
NI is never to be taken lightly! It's often NI that makes the real difference! Be it that additional pesky tax charge, or the relatively lower NICs paid by those in 2 P/T jobs!
I actually subscribe to the argument that dividend 'tax savings' have long been dividend 'NI savings' and not 'Income Tax savings' at all. Before 2016, the marginal IT + CT rates were 'more approximately' aligned with the progressive tax rates but had very little in the way of 'NI'. The introduction of the new dividend tax rates in 2016 brought those tax levels up to 'compensate' for some of the lost NI.
On missed opportunity... You probably won't find £10Ks, or even £1Ks of tax savings in a predictable 'fixed' trade. However for trades who see bienial/ trienial profits (e.g. property development, large event companies, touring musicians) the flexibility of declaring dividends in 'down years' can save a small fortune - in addition to the limited liability (etc.) aspect!
Tax efficiency
It goes the other way once company income increases
CT becomes 26% over £50,000 fairly soon, (on the margin).
NI for self employed drops to 3% when over the limit
Remember there's other things to consider than the rate of tax or NI.
Dividend nil rate, for instance. Or being able to control when you receive the earnings, and how much you receive (and potentially retaining entitlement to certain benefits).
Agreed that timing of profit extraction is an advantage and the main tax planning tool for my clients.
Not distributing or declaring profits for benefits purposes is benefits fraud so what do you mean?
Guessing gillybean04 meant exactly what they said - you have some flexibility here ref timing of income EVEN if you are claiming some benefits. the fact there are "anti avoidance rules" in place doesnt mean that there can be no advantage gained ref timing - one just needs to be sure one is staying within the rules if one is claiming benefits.
I don’t think this point belongs on this thread. When is it OK not to declare notional income and defraud the treasury?
You seem to be letting the tax dog wag the tail. Tax efficiacy should not be the driver behind whether or not to incorporate.
Everyone’s (temporarily) forgetting about MTDITSA’s 5 tax return pa. The digital record keeping might tip things slightly towards ltd for the smaller/older clients.
Until Limited companies also get within the event horizon (no doubt eventually) and they too get sucked into the MTD black hole.