FAQ: Dividend, Bonus Or Directors Fee, Which Is Better?

There is a degree of flexibility around how payments out of a company are made when you are the one responsible for making the decisions (ie the director). Three common forms of payments from a company are dividends, bonuses and directors’ fees. But first, what's the difference between them?

Dividends

Dividends are payments to shareholders, the owners of the company. If you are reading this it is most likely that you, your partner (if you have one) or another trust or related company owns the shares. Dividends are paid from the retained earnings of the company. Retained earnings are the profits that accumulate over the years net of any income tax that has been paid. As dividends are paid from retained earnings a tax deduction can’t be claimed, however a franking credit will attach itself to the dividend if the company has paid tax. If a dividend is fully franked it means that you receive a credit equal to the company tax that has been paid on the dividend amount. A dividend of $10,000 that is fully franked paid after 1 July 2022 will have a franking credit equal to $3,333, when the company tax rate goes from 26% to 25%. You can see how the franking credit has been calculated in calculation 2.

The franking credit is added to the dividend in the tax return of the recipient and tax is then calculated. If the recipient is an individual then they are taxed using marginal tax rates on $13,333. They then receive a credit for the $3,333 in tax paid by the company ($13,333 x 25%). The credit is deducted from the total tax payable which prevents the double taxation of company profits. To see this calculation in operation refer to calculation 2.

Bonuses and directors’ fees

The treatment of bonuses and directors’ fees are similar. They are both periodic lump sum payments made in connection with work done in the company. They are subject to PAYG withholding. Directors’ fees and some bonuses must also have super paid in respect of them. Furthermore these payments are reported to the ATO in the filing of single touch payroll data, Bonuses that are paid in respect of overtime are not subject to super. Bonuses and directors’ fees are considered to be incurred in order for a company to earn income and are therefore tax deductible.

Which is better?

So here we have different payment types with different tax treatments, is one better than the other? To illustrate I will use the example of Jack and Anne.

Jack and Anne separately operate their own companies and are not related to each other. If we were to pay a $10,000 dividend to Jack and a $10,000 bonus/directors’ fee to Anne and they both earned $100,000 of other income Jack would be $317 worse off than Anne (calculations 1 and 2). However we are not comparing apples with apples. Jack is actually receiving $13,333 in taxable income as he is also receiving a franking credit. If we were to pay Anne a bonus equal to Jack’s dividend and franking credit the tax result will be exactly the same. You can see this in comparing calculations 2 and 3. So it would seem that they are both the same, neither is better.

The franking credit system is designed such that the income from the company is ultimately taxed at the tax rate applicable to the dividend recipient and this is where the opportunity lies.

For example - Anne was a director only of her company and the shares were owned by her husband, Tony. Tony is a stay at home dad and doesn’t earn income from any other source. If Tony were paid a $10,000 fully franked dividend, then he would receive a tax refund of $3,333. This strategy would only work if the income derived by the company was not considered to be personal services income or from a personal services business. Our blogs FAQ: What is personal services income, do I earn any? and FAQ: What is a personal services business, is my business one? discuss the situations when this strategy can’t be used.

In conclusion

The decision on what type of payment to make purely depends on the circumstances of each situation as many different factors can come into play. If you have surplus cash in your company that you would like to get out and you are unsure as to the best way to go about it, have a chat with your accountant.

If you enjoyed this blog you might also like to check out our infographic 5 ways to pay yourself from your company or read The problem with leaving profits in your company.

This blog post was written in March 2021 and is in accordance with all tax rates and legislation applicable at that time.

If you would like specific advice tailored to your business and circumstances, Accounting Heart offers affordable service packages where you can work with Sonia one-on-one to help you get your business where you want it to be. Book your FREE Discovery Call to find out more.

Disclaimer: This is general information only and is not advice of any sort. No warranty or representation is provided by Accounting Heart Pty Ltd as to the accuracy, currency or completeness of the information contained in this blog. Readers of this blog should not act or refrain from acting in reliance upon any information contained herein and must always obtain appropriate taxation and / or other advice as may be appropriate having regard to their particular circumstances.