The tax pros and cons of benefits vs dividends

Profit extraction

Benefits in kind are one of the three main methods for director shareholders to extract income from their company. Except in one situation (see The next step ), benefits are more tax/NI efficient than salary, but generally, though not always, less tax efficient than dividends.

Benefits have an advantage over dividends because a company can provide them to a director even if it is loss making. This makes them a useful alternative or addition to salary in the early years of a company’s trading when it may not have enough profits from which it can pay sufficient dividends to meet a director shareholder’s needs.

When are benefits more tax efficient?

Benefits are more tax efficient than dividends where they are exempt from tax and NI in the hands of the director shareholder (see The next step ). Not only is there no tax for the recipient to pay but the company receives a tax deduction for them. The following tables compare the overall tax positions of a company providing an exempt benefit in kind compared with a dividend of an equal value.

	Company (£)	Director shareholder (£)
Benefit in kind	1,000	1,000
Corporation tax (CT) relief at 19%	-190
Net cost to company	810
Net value to director		1,000
Dividend	1,000	1,000
Minimum director's income tax		-88
Net cost to company	1,000
Net value to director		912

 

The figures assume the company pays tax at the small profits rate of 19% and the whole dividend is taxed at the dividend basic rate. Both the director shareholder and the company are better off with a benefit in kind rather than a dividend. The tax savings would be even greater where the company pays CT at the main or marginal rate, or the director is a higher or additional rate taxpayer.

When are benefits less tax efficient?

Generally, benefits which are taxable and liable to NI are less tax efficient than a dividend of the same value as the table below shows. However, where special rules apply for working out the taxable benefit resulting in a low taxable amount, e.g. zero or low emissions company cars, a benefit in kind might still edge a dividend for tax efficiency.

	Company (£)	Director shareholder (£)
Benefit in kind	1,000	1,000
Class 1A NI (13.8%)	138
Corporation tax relief (19% )	-216
Director-shareholder’s income tax		-200
Net cost to company	922
Net value to director		800
Dividend	1,000	1,000
Director's income tax		-88
Net cost to company	1,000
Net value to director		912