Dividend vs Bonus: The Year-End Extraction Question

1. The Two Mechanisms

A bonus is employment income, paid through payroll, deductible in the company's Corporation Tax return, subject to employer NIC at 13.8% (on earnings above the secondary threshold) and to the employee's income tax and employee NIC at the relevant bands. A dividend is a distribution of post-tax profit, not deductible by the company, not subject to NIC, and taxed on the recipient at the dividend rates (8.75% basic, 33.75% higher, 39.35% additional) after the £500 dividend allowance.

Both routes extract cash from the company to the shareholder. Which extracts more efficiently depends on the rate applying at each leg, company, employer, employee, and on what the shareholder-director has already taken in the year.

2. Bonus Arithmetic

A bonus of £X paid to a director costs the company £X plus 13.8% employer NIC, total £1.138X. That total is deductible, so at a 26.5% marginal CT rate the after-CT cost to the company is £1.138X x 0.735 = £0.836X. Put differently: every £1,000 of bonus paid to a director costs the company about £836 after CT relief, and the director receives £1,000 before personal tax and NIC.

On that £1,000 gross, the director pays income tax (20% / 40% / 45% depending on band) and employee NIC (8% on earnings between the primary threshold and the upper earnings limit, 2% above). A higher-rate director with earnings above the NIC upper limit pays 40% tax + 2% NIC = 42% on the gross, receiving £580 net.

3. Dividend Arithmetic

A dividend of £X is paid from post-tax profit. To generate £X of distributable reserves, the company first earns £X / (1, CT rate) of pre-tax profit. At a 26.5% CT rate, £1,000 of dividend requires £1,360 of pre-tax profit.

On that £1,000 of dividend, the director pays 33.75% dividend tax at higher rate (after the £500 allowance, if not already used). So the director receives £663 net. Total company + personal tax on £1,360 of pre-tax profit extracted as dividend: £360 CT + £337 dividend tax = £697, or 51%.

4. Side-by-Side Comparison

Comparing £1,000 of extraction from pre-tax profit to a higher-rate director, at a 26.5% company rate:

At 26.5% CT and higher-rate personal tax, the dividend is marginally better, the CT on the pre-dividend profit is offset by the NIC saving at the bonus stage. The margin is small and flips in either direction under different rate combinations.

5. When Each One Wins

• Bonus wins when: the company is in the 19% small profits rate (no CT saving on dividends worth much), or the director has not used their NIC primary threshold, or a pension contribution is being funded alongside, because a bonus can trigger relevant earnings for a larger employer contribution.
• Dividend wins when: the company is at the 26.5% marginal rate, the director is above the NIC upper limit and the £500 dividend allowance is unused, or the company prefers cash-timing flexibility (dividends need distributable reserves but not payroll processing).
• Pension beats both: where carry-forward and annual allowance allow, an employer pension contribution typically produces a materially better after-tax outcome than either bonus or dividend, CT relief plus no NIC plus tax-deferred growth.

6. Executing the Chosen Route

A bonus is paid through payroll in the period declared. For a year-end bonus to be deductible in that accounting period, the amount must be unambiguously earned (i.e., the director has a legal entitlement at year-end) and paid within nine months of the period end (s.1288 CTA 2009).

A dividend requires: distributable reserves (tested against the last filed accounts or an interim set), a board meeting to approve, board minutes, a dividend voucher issued to the shareholder, and the payment either made or credited to a loan account by the declaration date. The declaration date drives the personal tax year in which the income falls. Sloppy dividend paperwork is the single most common finding on an HMRC compliance check into owner-managed company extraction.