Is it better to take a dividend or a bonus?
February 7, 2013
It’s the time of year when many business owners are looking ahead to their 31 March accounting year end and, having worked hard all year to generate a profit for the company, are considering what profits they can extract from their business in the form of dividends or bonuses.
The normal wisdom when it comes to a “dividend v bonus” analysis by an accountant is that a dividend will typically be slightly more tax efficient than a bonus because a bonus will be subject to income tax and National Insurance Contributions for the recipient whilst the overall tax on a dividend is lower because of a tax credit which attaches to a dividend. The company which pays the bonus will also be subject to Employer’s National Insurance, whereas a dividend payment will not trigger any Employer’s National Insurance. The higher income taxes and National Insurance on a bonus will typically outweigh the benefit of any tax relief for the company on the bonus.
So far, so sensible. However, where the analysis breaks down is where, like many of our clients, the Owner Manager is involved in the process of carrying out R&D within the company and the company can claim the enhanced R&D Tax Relief as a result. The corporate tax rate within the company may be substantially below the normal rate paid by companies due to the extra relief on the R&D. Paying the owner manager who is involved in the R&D a bonus will increase the R&D Tax Relief for the company, whereas paying the Owner Manager a dividend will not.
The consequence of this is that the normal rules of “dividend v bonus” do not apply when the company is carrying on R&D and an Owner Manager is involved in the R&D. In that circumstance the analysis may reverse and a bonus may in fact be substantially more tax efficient overall. The analysis required to arrive at what the optimum answer to the “dividend v bonus” question for company doing R&D is highly complex as the Owner Manager’s involvement in the R&D needs to be quantified to enable the true answer to be found. However, the good news is that the optimum answer does exist – the action that Owner Managers in this situation should take is to consider before 31 March whether their traditional bonus v dividend strategies are in fact still correct!