November 2021

Everything business owners need to know about the new Dividend Tax rise

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At the start of September, the government announced some crucial tax changes as part of their plans to pay for social care reforms.

The 1.25 percentage point increase to the rate of National Insurance (NI) has been the mostly publicised change, affecting earners across the board. Most notably, the changes also mean that State Pensioners still in work also have to pay NI on their earnings when they didn’t previously.

However, this tax rise also came alongside the announcement of a 1.25% increase in the rate of Dividend Tax.

Many company directors and business owners use dividends to take income from their businesses. As a result, according to investment platform AJ Bell, company directors are most likely to be affected by this change, which will reportedly raise around £600 million in tax revenues.

So, if you’re a company director or business owner, find out everything you need to know about the Dividend Tax rise and how it might affect you.

Dividend Tax to increase by 1.25%

From next tax year, the Dividend Tax rate will rise by 1.25 percentage points.

However, this does not necessarily translate as a 1.25% tax increase for you, as the amount you pay in Dividend Tax is dependent on your marginal rate of Income Tax.

There is a tax-free Dividend Allowance before you have to pay Dividend Tax, which has been £2,000 since April 2019. However, any income taken in dividends above this threshold is subject to Dividend Tax.

For the 2021/22 tax year, Dividend Tax rates are:

Tax band

Tax rates on dividends over the allowance

Basic rate

7.5%

Higher rate

32.5%

Additional rate

38.1%

 

The 1.25 percentage-point increase to the Dividend Tax will then come into effect in the next tax year, starting on 6 April 2022.

From this point, the tax rates will become:

Tax band

Tax rates on dividends over the allowance

Basic rate

8.75%

Higher rate

33.75%

Additional rate

39.35%

 

A measurable impact on your income

While this increase may appear insignificant, it could have a serious impact on how you draw your income.

Let’s assume that you’re a higher-rate taxpayer, taking an income of between £50,271 and £150,000 each tax year from however you source your income. Let’s also assume that you’re yet to use any of your £2,000 Dividend Allowance.

Under the current rules, taking £10,000 of dividend income from your business would see you incur a Dividend Tax bill of £2,600.

But, from 6 April 2022, you’d have to pay £2,700, an increase of £100.

As with any percentage-based tax, the effect becomes greater the more income you take.

For example, drawing £20,000 under the current rules would see you charged £5,850. From 6 April 2022, you’ll have to foot a bill of £6,075, an increase of more than £200.

As a result, the more you take, the more this tax increase will affect you.

Dividends can still be worthwhile

Even with the impact of these changes, it’s worth noting that some analysis suggests that dividends can still be an effective way for company directors or owners to derive income from their businesses.

This is because the “effective” tax rate for dividends versus salary still favours taking dividends, even if that gap has now become smaller.

The effective rate is the average tax rate of your total taxable income, including your salary as well as “unearned” income such as dividends.

So, when taking the effective rate into account, your overall tax bill for taking income from dividends or salary, respectively, in the 2022/23 tax year would be:

Tax band

Effective rate of tax for dividend

Effective rate of tax for salary

Basic rate

26.09%

41.98%

Higher rate

46.34%

50.67%

Additional rate

50.87%

55.02%

 Source: FTAdviser

As you can see in the table above, business owners and company directors who pay basic-rate Income Tax could still cut their tax bill, even after the rise in Dividend Tax.

Indeed, even if you had to pay additional-rate Income Tax, your effective tax rate would nearly be lower when taking dividends than if you were a higher-rate taxpayer drawing a salary.

As a result, dividends may still be able to play a significant role in how you draw your income, even if just as a part of how you do so.

Work with us

If you’d like to find out more about how the Dividend Tax rate rise could affect you, or you’d like to find the most tax-efficient strategies for deriving income from your business, please get in touch with us at Holborn Financial.

We have years of experience in helping business owners and company directors just like you to help you make the most from all the hard work you put into your business.

Email info@holbornfinancial.com or call 020 8946 8186 to find out more.

Please note

This article is for information only. Please do not act based on anything you might read in this article. All contents are based on our understanding of HMRC legislation, which is subject to change.