Chancellor Rachel Reeves is said to be eyeing an increase to dividend tax in the Budget to bring it more in line with income tax, in what would be a blow to some business owners and investors.
Dividend tax is paid by investors who invest in dividend paying stocks and shares outside of an ISA or a pension. This income is taxed differently to income from earnings.
But many self-employed limited company businesses also pay themselves via a mixture of salary and dividends from their own company profits, so they would be hit by a hike too – potentially to the tune of thousands of pounds more in tax a year.
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The Resolution Foundation, which has close ties to the Treasury, has said the basic rate of dividend tax should be increased to at least 16.5%. However a 4 percentage point hike to the levy, coupled with a cut or abolition to the £500 tax-free allowance offered to investors, was more likely, the Telegraph said.
Such a move could reportedly be expected to raise nearly £2bn in extra funds.
End of the dividend tax-free allowance?
Removing the £500 tax-free allowance would mean even the smallest retail shareholder would have to inform HMRC of their investments.
The allowance has been sliced back repeatedly in recent years. It was halved in April 2024 from £1,000 but a little under a decade ago in 2016 when it was introduced it was significantly more at £5,000.
No change is expected to the higher and additional rates of dividend tax, which, at 33.75% and 39.35% respectively, are much closer to the corresponding rates of income tax.
Dividend tax was last put up by Conservatives in 2022, by 1.25 percentage points across the board.
The self-employed and pensioners are already expected to be worse off after the Budget if a mooted increase in income tax goes ahead.
While for employed workers the income tax rise would be offset by a cut in National Insurance, self-employed people don’t pay NI in the same way so won’t benefit. Likewise anyone over state pension age doesn’t pay National Insurance anyway.
What could an increase in dividend tax cost the self-employed?
Increasing dividend tax would likely mean self-employed directors – who typically mainly pay themselves via dividends from their company – would pay thousands more a year in tax.
MoneyWeek asked accountancy firm RSM to crunch the numbers.
The current basic rate for dividends is 8.75%. We assume a usual set-up for a business owner where they take a tax-free salary of £12,570 and then £37,700 in dividends to use up the basic rate band and bring total income to £50,270.
The business owner would currently incur income tax of £3,255 a year. This is based on taking the £37,700 in dividends, minus the £500 dividend allowance, multiplied by the 8.75% rate of dividend tax.
If the dividend tax rate was increased to 12.75%, the business owner’s tax burden rises to £4,743 a year.
But they could incur income tax of as much as £6,138 a year, based on rumours the dividend tax rate could rise to as high as 16.5%.
So, an increase in the dividend tax rate from its current basic level of 8.75% to the 12.75% rate would be an annual increase in income tax of £1,488 a year. To the 16.5% rate it would be an annual increase of £2,883 a year in extra tax burden on business owners.
Chris Etherington, private client tax partner at RSM UK, said: “If the 16.5% basic rate for dividends was introduced, the overall tax burden in the basic rate band would be virtually identical, regardless of whether profits were extracted as salary or dividends.
“However, the timing of payment of tax would differ, as you would be looking at higher corporation tax bills and income tax payments through self-assessment for dividends, rather than monthly payments through PAYE for a salary.
“The lower rate of tax on dividends is widely viewed as a reward for the risks that business owners take for being entrepreneurial, growing the economy and creating jobs. Therefore, an alignment of the tax on dividends and salaries could be very sensitive.
“However, it’s worth noting that the rates of tax for salary and dividends are already very closely aligned at the higher and additional rates of income tax.”
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