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Choice of Dividend or Bonus

Newsletter issue - June 07.

When you run your own company you have a good deal of flexibility over how and when to extract profits from your business. You may take a basic salary and top up your income with a dividend or bonus once or twice a year. Which of these alternatives is more tax efficient depends on your highest tax rate, and the tax rate paid by your company. But these tax rates are changing, so the policy that saved tax previously may not work in the future.

If you pay tax at the basic rate of 22% and your company pays corporation tax at 20%, the tax saved by you and the company combined is significant where those funds are extracted as a dividend. This is because the dividend is free of national insurance and income tax in your hands.

Where the bonus or dividend you receive pushes your personal income into the higher rate tax band (taxed at 40%) there is still a combined tax saving by paying a dividend, if the company pays tax at 20%. However this tax saving will reduce as the corporate tax rate rises to 22% in 1% stages in 2008 and 2009.

If your company pays the higher or marginal rates of corporation tax, (currently 30% to 32.5%) and you are already paying 40% on part of your income, there is no tax saved overall by paying a dividend rather than a bonus.

Although a dividend is a tax efficient way to extract profits in most cases, there are alternatives. For example if the company uses a property, which is held in your own name, it can pay you a market rent which is free of national insurance. Ask us to look at how you could extract more profits from your company in tax efficient ways.

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