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Business Services  •  Business Tax  •  Corporate Taxation  •  Personal Taxation

Planning ahead for the increase to dividend tax

By RJP LLP on 29 November 2021

The Government is increasing dividend tax (and national insurance) by 1.25% and this will have quite an impact on shareholders. This is one of the changes introduced with the Health and Social Care Levy and has already been written into Finance Act 2021.

Take it while you can?

Given that many company director/ shareholders draw a combination of salary and dividends from their companies, this change requires some forward tax planning. It may be advisable to consider voting a slightly higher dividend before the increase comes into operation and this article outlines some things to be aware of before making any decisions. It also explains what is happening and provides company directors with guidance on what, if any, action they may wish to take.

Understanding dividends

Firstly, it is important to understand how dividends work since they are distinct from bonuses or other forms of remuneration. A dividend is a payment of profits (taken after corporation tax) to company shareholders. It can only be voted if there are sufficient profits available and accrued within the company, or it is effectively an illegal dividend. Dividends are treated differently to salary within the company’s accounts as salaries are tax deductible for the company and reduce the amount of corporation tax payable.

Most company director/ shareholders will be aware that dividends suffer lower rates of income tax in their hands than salary, although this is of course offset by the fact that the company making the payment has not received corporation tax relief on the dividends paid.

This lower rate of personal tax has slowly been eroded; beginning after the government introduced a tax-free dividend allowance of £5,000 for all taxpayers and then restricted it to £2,000 in 2018, after which tax is payable at different rates, depending on the levels of total income of the individual recipient.

Note the £2,000 tax free allowance includes all forms of dividends, including those received from investment shares. If your spouse is also entitled to a shareholder dividend, it may be possible to utilise their allowances in addition.

The tax rate applicable to the dividend is then applied after corporation tax, which is increasing to a 25% headline rate in 2023, with marginal relief between £50,000 and £250,000 of company profits.

The actual dividend tax payable will depend on how much income and capital gains was received in the tax year. Current rates of dividend tax (payable after the £2,000 allowance) are: Basic rate: 7.5%, Higher rate: 32.5% and Additional rate: 38.1%.

For the 2022-23 tax year, this will be increasing by 1.25% in each tax band, to the following rates.

Tax bands for 2022-23 tax year

Tax band *Proposed
from 2022-23
Current rates
Basic rate8.75%7.5%
Higher rate33.75%32.5%
Additional rate39.35%38.1%
For the 2022-23 tax year, this will be increasing by 1.25% in each tax band, to the following rates.

Importantly, these figures are based on current tax bands and may change; the additional rate bracket may be altered to catch greater numbers of taxpayers; or the current £2,000 tax free dividend allowance may be removed – details of these two considerations have not yet been released by the government.

How is the dividend tax applied? Income Scenario Examples

Income less than £12,570 falls within the personal allowance and no tax is due. It is possible to earn up to £14,570 in total (using the £2,000 dividend tax allowance) without incurring any tax.

Income up to £52,270 (including the personal allowance and the dividend tax allowance) falls within the basic rate of tax bracket, currently 7.5% but due to rise to 8.75%.

Income between £52,270 and £150,000 falls within the higher rate tax bracket, currently 32.5% and due to rise to 33.75%. (Although note that if total income exceeds £100,000, the personal allowance is gradually withdrawn with the effect that income from £39,700 falls within the higher rate tax bracket)

Income above £150,000 falls within the additional rate tax bracket, currently 38.1% and due to increase to 39.35%.

Given these increases, in situations where sufficient company profits are available, it may be advisable to pay increased dividends before the new dividend tax takes effect. Provided the company has reserves available, dividends can be voted and credited to the director/shareholder loan account. Although the personal tax liability is based on this date of credit, the funds can be retained within the company until cash is available.

Example showing potential tax savings of an increased dividend before 2022-23 tax year

Additional rate taxpayer

Salary of £130,000 and dividend income of £150,000, based on 2021-22 tax bands.
 Tax paid
2022-23
Tax paid
2021-22
Salary £130,000
£0 covered by personal allowance (lost due to income level)
£37,700 taxed at basic rate 20%7,5407,540
£92,300 taxed at higher rate 40%36,92036,920
Balance of higher rate band remaining £20,000
Dividend £150,000
£20,000 falls within higher rate band of 32.5%/ 33.75% with £2,000 covered by the dividend allowance6,0755,850
£130,000 falls within the upper rate band and is taxed at 39.35%/38.1%51,15549,530
Total tax payable£101,690£99,840 
Difference£1,850

Other factors to consider

Additional considerations if you are thinking about taking a higher than usual dividend before the tax increase is whether you intend to sell your company in the short term. An unusually large dividend payment could impact on the future price you can secure for your company.

If you are considering whether to wind the company up, this may be a better option than taking a larger dividend as the funds may be chargeable to capital gains tax rather than income tax.

The rate of tax applied to overdrawn directors’ loan accounts is also increasing by 1.25% from April 2022, from 32.5% to 33.75%. This is a good reason not to vote an additional dividend unless funds are available.

Clearly this is a complicated change to the tax regime and each taxpayer’s situation needs to be evaluated individually to understand the best option to take.

If you would like advice on tax planning in advance of the April 2022 increases, please contact us via partners@rjp.co.uk.

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The Government is increasing dividend tax (and national insurance) by 1.25% and this will have quite an impact on shareholders. This is one of the changes introduced with the Health and Social Care Levy and has already been written into Finance Act 2021.

Take it while you can?

Given that many company director/ shareholders draw a combination of salary and dividends from their companies, this change requires some forward tax planning. It may be advisable to consider voting a slightly higher dividend before the increase comes into operation and this article outlines some things to be aware of before making any decisions. It also explains what is happening and provides company directors with guidance on what, if any, action they may wish to take.

Understanding dividends

Firstly, it is important to understand how dividends work since they are distinct from bonuses or other forms of remuneration. A dividend is a payment of profits (taken after corporation tax) to company shareholders. It can only be voted if there are sufficient profits available and accrued within the company, or it is effectively an illegal dividend. Dividends are treated differently to salary within the company’s accounts as salaries are tax deductible for the company and reduce the amount of corporation tax payable.

Most company director/ shareholders will be aware that dividends suffer lower rates of income tax in their hands than salary, although this is of course offset by the fact that the company making the payment has not received corporation tax relief on the dividends paid.

This lower rate of personal tax has slowly been eroded; beginning after the government introduced a tax-free dividend allowance of £5,000 for all taxpayers and then restricted it to £2,000 in 2018, after which tax is payable at different rates, depending on the levels of total income of the individual recipient.

Note the £2,000 tax free allowance includes all forms of dividends, including those received from investment shares. If your spouse is also entitled to a shareholder dividend, it may be possible to utilise their allowances in addition.

The tax rate applicable to the dividend is then applied after corporation tax, which is increasing to a 25% headline rate in 2023, with marginal relief between £50,000 and £250,000 of company profits.

The actual dividend tax payable will depend on how much income and capital gains was received in the tax year. Current rates of dividend tax (payable after the £2,000 allowance) are: Basic rate: 7.5%, Higher rate: 32.5% and Additional rate: 38.1%.

For the 2022-23 tax year, this will be increasing by 1.25% in each tax band, to the following rates.

Tax bands for 2022-23 tax year

Tax band *Proposed
from 2022-23
Current rates
Basic rate8.75%7.5%
Higher rate33.75%32.5%
Additional rate39.35%38.1%
For the 2022-23 tax year, this will be increasing by 1.25% in each tax band, to the following rates.

Importantly, these figures are based on current tax bands and may change; the additional rate bracket may be altered to catch greater numbers of taxpayers; or the current £2,000 tax free dividend allowance may be removed – details of these two considerations have not yet been released by the government.

How is the dividend tax applied? Income Scenario Examples

Income less than £12,570 falls within the personal allowance and no tax is due. It is possible to earn up to £14,570 in total (using the £2,000 dividend tax allowance) without incurring any tax.

Income up to £52,270 (including the personal allowance and the dividend tax allowance) falls within the basic rate of tax bracket, currently 7.5% but due to rise to 8.75%.

Income between £52,270 and £150,000 falls within the higher rate tax bracket, currently 32.5% and due to rise to 33.75%. (Although note that if total income exceeds £100,000, the personal allowance is gradually withdrawn with the effect that income from £39,700 falls within the higher rate tax bracket)

Income above £150,000 falls within the additional rate tax bracket, currently 38.1% and due to increase to 39.35%.

Given these increases, in situations where sufficient company profits are available, it may be advisable to pay increased dividends before the new dividend tax takes effect. Provided the company has reserves available, dividends can be voted and credited to the director/shareholder loan account. Although the personal tax liability is based on this date of credit, the funds can be retained within the company until cash is available.

Example showing potential tax savings of an increased dividend before 2022-23 tax year

Additional rate taxpayer

Salary of £130,000 and dividend income of £150,000, based on 2021-22 tax bands.
 Tax paid
2022-23
Tax paid
2021-22
Salary £130,000
£0 covered by personal allowance (lost due to income level)
£37,700 taxed at basic rate 20%7,5407,540
£92,300 taxed at higher rate 40%36,92036,920
Balance of higher rate band remaining £20,000
Dividend £150,000
£20,000 falls within higher rate band of 32.5%/ 33.75% with £2,000 covered by the dividend allowance6,0755,850
£130,000 falls within the upper rate band and is taxed at 39.35%/38.1%51,15549,530
Total tax payable£101,690£99,840 
Difference£1,850

Other factors to consider

Additional considerations if you are thinking about taking a higher than usual dividend before the tax increase is whether you intend to sell your company in the short term. An unusually large dividend payment could impact on the future price you can secure for your company.

If you are considering whether to wind the company up, this may be a better option than taking a larger dividend as the funds may be chargeable to capital gains tax rather than income tax.

The rate of tax applied to overdrawn directors’ loan accounts is also increasing by 1.25% from April 2022, from 32.5% to 33.75%. This is a good reason not to vote an additional dividend unless funds are available.

Clearly this is a complicated change to the tax regime and each taxpayer’s situation needs to be evaluated individually to understand the best option to take.

If you would like advice on tax planning in advance of the April 2022 increases, please contact us via partners@rjp.co.uk.