Is it more tax efficient to take salary or dividends?

Salary vs Dividends: Tax Efficiency

This is a common question for owner-managers of limited companies. Based on the available source materials, here is what the law and HMRC guidance say about the key tax differences. Note that the answer is highly dependent on individual circumstances — there is no single universally correct answer.

What the law says

Dividend tax rates are set separately from income tax rates on employment income. Under ITA 2007 s.8, the rates are:

• Dividend nil rate: 0%
• Dividend ordinary rate: 8.75% (basic rate taxpayers)
• Dividend upper rate: 33.75% (higher rate taxpayers)
• Dividend additional rate: 39.35% (additional rate taxpayers)

These rates are lower than the equivalent income tax rates on salary (20%, 40%, 45%), which is a key reason why dividends are often considered more tax-efficient.

The dividend nil-rate allowance (sometimes called the "dividend allowance") means a certain amount of dividend income is charged at 0%. This was reduced to £1,000 for 2023-24 and further reduced to £500 for 2024-25 and subsequent tax years.

Salary attracts Class 1 National Insurance Contributions (NICs) — both primary (employee) and secondary (employer) — whereas dividends do not. Workers liable to pay Class 1 NICs are those whose weekly income is at or above the Lower Earnings Limit.

HMRC guidance / practice

Owner-managers commonly pay a mix of salary and dividends. HMRC guidance and tribunal decisions confirm this is a legitimate and common approach. For example, one case noted that a director "tends for tax reasons to pay himself from the company in a mix of salary and dividends" — paying a modest salary of £400/month alongside annual dividends of £5,000–£10,000.

There is nothing unlawful about structuring remuneration tax-efficiently. A tribunal confirmed that "there was nothing to prevent the sole owner and director of a company from arranging for the profits of the company's business to be extracted in the form of salary and as dividends/distributions in such proportions as he or she may wish."

HMRC also accepts that "a taxpayer does not necessarily have a tax avoidance purpose if, when faced with a choice as to how to structure a commercial transaction, he structures it in a manner which is more tax efficient than other ways."

However, dividends can only be paid out of distributable profits — a company must have sufficient retained profits to declare a dividend lawfully. Salary, by contrast, is a deductible business expense that reduces the company's corporation tax liability.

Practical trade-offs to consider:

A typical efficient structure for a director-shareholder is to pay a salary up to the NIC secondary threshold (to preserve state benefit entitlement without triggering employer NICs), with the remainder of drawings taken as dividends — utilising the dividend nil-rate band and lower dividend tax rates. This is illustrated in HMRC guidance where a PSC pays a salary of £5,800 with the remainder taken as dividends.

⚠️ Important caveats: The optimal split depends on your total income level, whether you are a Scottish taxpayer (Scottish income tax rates apply to salary but not dividends), the company's corporation tax rate, IR35/off-payroll working rules, and your personal circumstances (e.g. pension contributions, mortgage applications, state benefit entitlement). You should seek personalised advice from a qualified tax adviser.