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Dividends vs salary

Choosing between dividends and salary tax (PAYE) strategies can be complex for business owners. While distributing dividends can in some instances certainly optimise tax efficiency, it's surprising how often accountants get this wrong and how many business owners are uninformed about dividend distribution and the overall tax burdens associated with them. Here are some key points to consider before making the decision on dividends vs salary: - A company cannot distribute dividends without retained earnings or retained income (net profit after company income tax) reflected on its balance sheet. Dividends can only be distributed from company profits remaining after paying income tax on those profits. - After applying the company tax rate to company profits (i.e. a flat rate of 27% or SBC rates for SMEs), an additional 20% dividends withholding tax must be paid to SARS to get the money into the hands of the shareholders/owners, which in turn impacts the overall tax burden. - Opting not to draw a monthly salary, despite attracting PAYE for the business owner, means losing out on a tax-deductible expense in the company’s tax calculation - In an example with R1 million profit before tax: - Foregoing a monthly salary and instead declaring a dividend of R730 000.00 after paying R270 000.00 (R1 million x 27%) income tax on the company profits results in an effective tax rate of 41% (combined company and dividends withholding tax). - Foregoing a dividend and drawing an annual salary of R730 000.00 (which is a gross salary of R60 833.00 per month) and paying tax on R270 000.00 (R270 000.00 x 27%) company profits, results in an effective tax rate of approximately 27%. (This is even more favourable if you are taxed as a small business) These calculations vary case by case, and can be affected by potential and multiple income sources in the business owners capacity as well as available profits for distribution in the company, however, Business owners should weigh the OVERALL tax burden between themselves and their company before making decisions based on misunderstanding tax calculations.