D6.642 Profit extraction from family companies—salary or dividend
In the light of the considerations described in D6.641, the starting point for any discussion of profit extraction from a family company must be a comparison between salary and dividend. There are other ways of extracting profits, some of which have their place in an overall package, but there is little point in addressing these in detail until the basic balance between salary and dividend has been struck.
If the prima facie results described in D6.641 were all that mattered, business proprietors would always much prefer to take a dividend, as the rate of income tax to be suffered is less. However, as a family company is involved, it is necessary to also consider the effect on the company in order to determine the total tax liability (of both the business and its proprietor).
The tax system that is now in force seems to have come about largely by accident. The free use of dividends has already caused HMRC to take rearguard action in one significant circumstance, namely the introduction of the 'IR35' legislation, see Division E4.10. Many commentators regard HMRC's use of the settlements legislation (see D6.651) as a further example of similar action.
Nevertheless, for the most part, dividends are still currently the preferred option. Future changes may tip the balance the other way, in which case advisers will have to meet new challenges and adapt their strategies accordingly.
The examples that follow demonstrate how the current rules operate.
Higher rate taxpayer