Extraction of Profits: Dividend vs Bonus
The increases in income tax rates introduced in the 2009 Budget will mean that the effective tax rates for extracting profits from companies will change. Table 1 below gives an overview of the position for the next three years. The table assumes that the taxpayer has income in excess of £150,000.
You will see that, following the increase in income tax rates to 50% from 6 April 2010, the effective rate of tax for extracting profits increases significantly. The underlying conclusion is that where profits are extracted from a company, a dividend will result in a lower tax burden overall.
Consideration may be given to paying bonuses and/or dividends before 6 April 2010 when the increases in tax rates are introduced. By way of example, paying a £100,000 bonus before 6 April 2010 rather than afterwards would result in an increase in net cash received of £8,865. The amounts paid out could be lent back to the company.
As shown in Table 1 above, trading through an unincorporated business would give a lower overall effective tax rate than a company. In a scenario where not all profits are required to be extracted, however, the analysis will often be different as shown by the example below in Table 2.
Here, as all of the profits are being taxed at the higher rate of income tax, irrespective of the drawings, there is a marked difference between an unincorporated business and a company. This may lead one to think that incorporation is now commercially more viable than before. Clearly, every businesses fact pattern will be different and specific advice should be taken for your particular circumstances.
For further information or specific advice on the above please contact Craig Hughes on 0115 983 5595 or 07717 840596 or email chughes@edftax.co.uk.
