Company directors who are also shareholders often face the question of how best to extract profits from their limited company — via salary, dividends, or a combination of both. Each option has different tax implications, cash flow considerations, and legal responsibilities. Choosing the right route can have a significant impact on both personal income and the company’s financial health.
Understanding the Basics
Salary is paid as employment income through the company’s PAYE (Pay As You Earn) scheme. This means it is subject to income tax and National Insurance Contributions (NICs). Directors must report salaries through payroll, and both employee and employer NICs will apply.
Dividends are payments made to shareholders out of the company’s post-tax profits. They are not subject to NICs but do incur dividend tax once the annual dividend allowance is exceeded. Dividends must also be supported by sufficient retained profits and formally declared by the company’s board.
Tax Considerations
One of the key advantages of taking dividends is that they are more tax-efficient than salary at most income levels. For the 2025/26 tax year, the dividend allowance is £500, and dividends above this are taxed at:
- 8.75% for basic rate taxpayers
- 33.75% for higher rate taxpayers
- 39.35% for additional rate taxpayers
In contrast, salary attracts income tax at the standard rates (20%, 40%, 45%) and both employee and employer NICs. From April 2025, employer NICs will increase from 13.8% to 15%, and the secondary threshold — the point at which employers start paying NICs — will fall to £5,000.
Therefore, from a purely tax perspective, dividends are often preferable, particularly for directors earning moderate levels of income.
Pension Contributions and Other Benefits
However, salary does come with certain benefits. Only salary counts towards qualifying earnings for state pension entitlement and other benefits such as maternity pay or borrowing capacity for mortgages. In addition, pension contributions made by the company on behalf of the director are only allowed as a deductible expense if the director is on payroll.
Cash Flow and Company Profits
Dividends can only be paid out of retained profits — meaning if the company makes a loss or has insufficient reserves, dividends cannot legally be declared. This makes salary a more reliable form of income in leaner times.
Moreover, salaries are an allowable business expense, reducing the company’s Corporation Tax bill, whereas dividends are not.
Legal and Administrative Differences
Paying a salary involves setting up a PAYE scheme and filing regular RTI (Real Time Information) submissions to HMRC. While this adds some administrative overhead, it’s often necessary anyway if the company employs staff.
Dividends require less frequent reporting, but directors must ensure they follow proper procedures: holding board meetings, recording dividend declarations in minutes, and issuing dividend vouchers to shareholders.
A Combined Approach
For many directors, the most efficient approach is a combination of both:
- Salary up to the NIC threshold (currently £12,570) to utilise the personal allowance and maintain eligibility for state benefits.
- Dividends for additional income, minimising overall tax and NIC liability.
This strategy enables directors to maintain a steady income, keep NICs low, and still benefit from Corporation Tax efficiency.
Final Thoughts
There is no one-size-fits-all answer. The optimal mix of salary and dividends depends on a range of factors, including personal income needs, company profitability, pension planning, and future goals.
Company directors should seek tailored advice from a qualified accountant or tax adviser — such as CMA Accountancy — to ensure they are making the most tax-efficient decisions while remaining compliant with HMRC rules.