R&D tax relief is expanding rapidly with the number of claims made by companies increasing 20% year on year. In recent years, it has been very common for director shareholders to remunerate themselves with a low salary to maintain their National Insurance record while drawing the balance of their pay package by dividends which have lower rates of Income Tax than salary/no National Insurance contributions. This results in significant tax savings for the individual.

However, when it comes to R&D tax relief, the picture for the company becomes less rosy. As mentioned above, an often-misunderstood rule is that dividends paid to directors qualify for relief. So, all that hard work spent on R&D by a large number of directors in the UK today accounts for very little reward in R&D tax relief terms – a disappointing message to communicate to clients.
As the dividend tax savings were always historically attractive (especially when there was a zero % tax rate in the basic rate band up to two years ago), there was little to counter this strategy as in the round a director would need to be more or less 100% devoted to R&D to make a switch to salary effective and when coupled with the other duties of running a business was a pretty unachievable feat!
With the reforms of dividend taxation in April 2016, the equation changed with the imposition of a new rate of 7.5% in the basic rate band, and higher rates for higher earners as the government sought to level the playing field.

Income tax rates

Pre 1/4/16

Post 1/4/16

Basic rate

0%

7.5%

Higher rate

25%

32.5%

Additional rate

30.56%

38.1%

Note £5,000 annual allowance available (reducing to £2,000 in 18/19)

uddenly, the balance shifted and when you bring R&D tax relief into the equation, it can now work out in favour of adopting a salary basis for hands-on directors. You can easily calculate the point at which it becomes more tax efficient for you to use a salary vs dividend based on the percentage of your time spent on R&D.

To obtain the details on Dividend vs. Salary for R&D Performers, download our report.