Tax Tax Advice

Are dividends still more tax-efficient than a large salary?

5 May 2021

Dividends or salary?

One of the most important decisions a small business owner will make, at least when it comes to tax efficiency, is how they draw an income from their limited company.

Prior to April 2016 small business owners could reduce their annual tax bills quite considerably by taking a smaller salary and then distributing the remaining profits to shareholders as dividends. That’s because before April of this year basic rate taxpayers had a 10% dividend tax liability but also had their dividend income “grossed up” by 10% via a dividend tax credit, meaning all dividend income that fell below the higher rate tax band was effectively tax-free.

Similarly, effective dividend tax rates for higher rate and additional rate taxpayers were reduced by 10% thanks to this dividend tax credit.

New dividend tax rates

George Osborne’s decision to introduce a new 7.5% rate of dividend tax, and replace the 10% dividend tax credit with a £5,000 dividend allowance, means taxpayers will now be hit with a new 7.5% tax bill on any distributions between £5,000 and £32,000, while the effective dividend tax rates for higher and additional rate taxpayers have also risen by 7.5%.

So, should small business owners revert to paying themselves a larger salary? Not so fast…

Sole trader or limited company?

Firstly, it’s worth considering the situation for a business that hasn’t yet incorporated.

If a sole trader is trying to decide whether or not it’s still worth incorporating, and in particular is pondering whether these new dividend tax rates may have completely eliminated the tax savings that came from setting up a limited company, then one of our recent articles should help with this decision.

As that article points out, even with the 7.5% hike in dividend tax a sole trader earning £60,000 a year would still be more than £2,000 better off if he or she set up a limited company and extracted the bulk of the company’s profits as dividends.

Tax on salaries

The difference is even more pronounced if a small business owner has already incorporated and is deciding whether to take a larger salary or issue a larger dividend.

If a small business owner chooses to draw an income from his or her business through a salary then the following income tax rates will apply:


Income Tax rate

The first £11,000


£11,000 to £43,000


£43,001 to £150,000


£150,001 or more


So a small business owner taking a full salary of £60,000, for instance, would pay just shy of £13,200 in Income Tax.

However, as an employee the business owner will also have to pay Employee’s National Insurance Contributions, which amounts to £4,532.40 on this salary. In addition, and in contrast to a sole trader, because this limited company director is recognised as both the employee and the employer, he or she will also have to pay Employers’ National Insurance Contributions.

The net result is that a £60,000 salary would incur a total tax bill of almost £25,000 when Employers’ NI is factored in (which alone accounts for £7,160.64), compared with a tax bill of around £15,000 if the bulk of the company’s profits were distributed as dividends.

Net result? A saving of almost £10,000 if the business owner took a small annual salary and paid out the balance as dividends.

A spreadsheet showing our full dividend and salary calculations can be downloaded here.

Are there any disadvantages of taking a low salary and high dividend?

Of course, there are some occasions when dividends may be less than ideal.

If a small business has more than one owner, for instance, then salaries allow for greater flexibility when distributing profits, because the owners can agree whichever salary arrangements best suit the business (and the business owners). Dividends, on the other hand, must be distributed in proportion to the owners’ specific shareholdings (unless one of the shareholders agrees to a dividend waiver, of course).

In addition, business owners can pay themselves a salary even when a business makes a loss, whereas dividends can only be paid if a business is profitable. Corporation Tax must be paid before a dividend is issued (whereas a salary is paid before Corporation Tax), and the size of the company’s distributable reserves after Corporation Tax will determine how large the dividend can be ( a lesson which the singer Adele recently learned the hard way).

Dividends are still the best option?

Small business owners were understandably upset over Osborne’s decision to introduce a new 7.5% dividend tax, and obviously the changes have reduced, at least to some extent, the tax efficiencies small business owners gain from dividends.

However, although they’re now hit with higher tax, and although they may not work in every situation, dividends still remain the most tax-efficient option for drawing an income from a limited company.

And for sole traders dividends continue to offer a significant incentive to incorporate, George's new dividend taxes notwithstanding.

For advice on the most tax efficient and suitable way to structure your business or for efficient and affordable tax and accounts services, please do get in touch with us. We're a very modern, enthusiastic and entrepreneurial professional services business which embraces technology and modern ways of working.