Salary vs Dividends: When should companies allocate payments to shareholders?

For companies deciding how to allocate payments to shareholders, understanding the tax implications of salary versus dividends is essential. Each option has unique advantages and tax consequences that can significantly affect both the company and the individual shareholder. This is particularly important in February 2025, the final month of the 2024-2025 payroll cycle.

1. Salary: Tax implications

Salary payments are considered earned income and are subject to the following tax implications:

  • Income Tax: Salaries are taxed according to the individual’s marginal tax rate, which ranges from 18% to 45%.
  • PAYE (Pay-As-You-Earn): Companies must deduct PAYE on salary payments and remit it to SARS.
  • Employer Registration: If a company isn’t registered to pay PAYE, the salary is still subject to normal income tax rates through the provisional tax process. 

Pros of salaries:

  • Provides a steady income stream to shareholders.
  • Enables contributions to retirement funds, which may reduce taxable income.
  • Tax-deductible expense for the company, reducing corporate tax liability.

Cons of salaries:

  • Subject to higher tax rates for high-income earners.
  • Requires monthly PAYE administration.

2. Dividends: Tax implications

Dividends are distributions of after-tax profits and have distinct tax treatment:

  • Dividends Withholding Tax (DWT): Subject to a flat 20% withholding tax for individuals.
  • Corporate Tax: Ordinary companies pay 27% corporate tax before distributing dividends, while Small Business Corporations (SBCs) pay 0% to 27%, depending on profit levels.

Effective tax rate on dividends:

  • A company earning R100 in profit pays 27% corporate tax, leaving R73.
  • A 20% dividend tax on R73 results in R58.40 for the shareholder.
  • For SBCs, the effective tax rate ranges from 20% to 41.6%, depending on profitability.

Pros of Dividends:

  • Lower tax rate than the top marginal income tax bracket.
  • No PAYE or UIF obligations.
  • Not subject to the 1% SDL (Skills Development Levy).

Cons of Dividends:

  • Not tax-deductible for the company.
  • Requires sufficient after-tax profits before distribution.
  • Must pass a solvency and liquidity test.

3. When to Choose Salary vs Dividends

The decision depends on:

  • Tax efficiency: For high-income earners, dividends may be more beneficial, while lower earners might find salaries more tax-efficient.
  • Company profitability: Salaries can be paid regardless of profitability, while dividends require after-tax profits.

As we enter the final month of the payroll cycle (March 2024 to February 2025), businesses should evaluate whether to shift from salary to dividends for February. By assessing the company’s profits, shareholders can determine the most tax-efficient way to withdraw earnings.

Companies are encouraged to consult tax professionals to optimise their tax strategy before the financial year-end.

[Author:  Michael Rushby]

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