Dividends and R&D tax explained
Being a company director is a great way to get one over on HMRC. You can pay yourself a nominal salary and pocket the lion’s share of your income as low-tax directors’ dividends instead. You 1, HMRC 0.
However, if you’re making a claim for money back from the government through its scheme to help businesses with their research and development costs, what seemed like a way to keep more of your profits may actually cause you to lose out.
Salaries, dividends and the R&D tax credits scheme
The r and d tax credit scheme helps companies pursuing advancements through the use of science and technology by reimbursing some of their costs. These costs include, among other things, the salaries of people working on the research and development project you’re claiming for.
In contrast to a salary, a dividend is a payment a limited company makes to its shareholders when it has made a profit. Company directors often pay themselves largely through these, as they don’t incur as much income tax or any national insurance. The small salary they do take, however, allows them to build up their state pension record.
Dividends are, therefore, explicitly not a salary, and you can’t claim them as a cost to be reimbursed (which is completely fair; you can’t take measures to reduce your tax and then expect to benefit from a tax break). So if, as a director, you’re significantly involved in research and development, you might actually be better off paying yourself a salary, and claiming all or part of it back through the scheme.
So, salary or dividend?
This is a complicated matter on which you need to take proper financial advice, as it can affect your shareholders’ agreement and your wider tax situation. That’s because unless you’ve agreed otherwise, all shareholders with the same class of shares must take the same level of dividend. Dividends may still work out better value, but it’s definitely something you need to consider.
When working out which is the better option, make sure you calculate accurately the amount of time you’ve devoted to research and development. You can claim for the appropriate proportion of your salary, according to how much time you’ve spent on the project; so if half your time is spent on it, you can claim for half your salary. But you don’t have to be making the advancements personally: time spent on activities which aren’t research but are a necessary part of the project, such as project management, meetings and supervision, can count too.
The Institute of Financial Accountants says: “Roughly speaking, shareholders spending 70 per cent or more of their time on research and development may be better with 100 per cent salary as opposed to dividends.”
There are other pitfalls to avoid regarding salaries and dividends when making a claim too. As such, it’s always best to seek advice from a specialist when submitting your application. For an idea of how much you might be able to claim, take a look at this r&d tax credits calculator.
