Contractors’ Questions: What’s the best salary-dividend split for a limited company?

Contractor’s Question: It’s an age-old query, and one that contractors seem to have a lot of opinions about, but what is the best split of salary and dividends for a limited company contractor?

Expert’s Answer: First we’d like to explain that the reason contractors choose to pay themselves a modest salary, topped up with dividends is because of the implications associated with drawing a ‘£Nil salary.’ So, one way of doing this would be to pay yourself a basic salary up to the limit of when NI contributions become payable (the threshold for the current 2018/19 tax year is £8,424).

It’s entirely up to you whether you do this, but it’s worth noting that remuneration at the NI threshold is lower than the National Minimum Wage, and as a director without a contract of employment, you’re not bound by national minimum or living wage legislation.

From April 1st this year, the National Minimum Wage for people aged 25 and over is £7.83 an hour which, when full-time hours are considered, works out at about £14,250 per year. Taking a salary at this level might be better than taking one below the NI threshold, as it shows your willingness to operate a genuine contracting business. There’s no advantage to withdrawing a salary in excess of this figure however, except in special circumstances.

As mentioned earlier, you can take all your income as dividends and draw no salary at all (£Nil salary) if you like, but if you do this, watch out for the following:

• Effect on future entitlements

£Nil salary means you won’t pay National Insurance. However, not paying NI contributions could affect things later on down the line, including entitlements such as the state pension and other state benefits.

• Investigations by HMRC

If you don’t take any salary from your business, it might appear to HMRC that dividends paid or declared incorrectly are in fact ‘salary in disguise.’ This could lead to HMRC taxing the dividends as salary.

Salary that your company pays to you qualifies for corporation tax relief. This means that if your company pays you £8,424, it will save £1,600 in corporation tax. This combined with the fact that this income is tax-free for you (as it’s within your personal allowance), makes a nominal salary very tax-efficient.

Ultimately, striking the right salary/dividend balance will totally depend on your individual circumstances, and factors will need to be considered such as:

• Your age
• Likely length of career
• Projected income levels
• Views of pensions planning and saving
• Family status
• Income from outside the business
• IR35 risk status
• Cash requirements to fund lifestyle

We agree there’s a lot to bear in mind when making decisions about your salary and dividends, so it’s best to draft in the professionals. In the tax and accounting space, we recommend you look for those who have expertise on what we’ve outlined -- how best to withdraw income from your company, but also on how best to get your business up and running for the legislative challenges that may lie ahead.

The expert was Patrick Gribben, head of client services at contractor accountancy firm Intouch Accounting.