Alongside recently announced rises to Corporation Tax and National Insurance, the prime minister has confirmed that the rates of Dividend Tax will increase in April 2022.
Business owners and company directors who receive part or all of their salary through dividends will therefore see their tax rise in the spring.
So, does this increase make taking dividends less attractive? Read on to find out how the increase will affect your overall tax position, and for an alternative method of extracting income from your business which could offer tax savings.
A reminder of what is happening to Dividend Tax in April 2022
To fund the NHS recovery from Covid-19 and the government’s new social care proposals, Dividend Tax will rise by 1.25 percentage points from April 2022.
If you take home more than £2,000 a year in dividends, your tax bill will rise from April 2022.
For example, if you’re a basic-rate taxpayer and you receive £5,000 in dividends, then you will pay Dividend Tax on £3,000. The tax rise means that your bill will rise from £225 to £262.50.
Alternatively, if you’re a higher-rate taxpayer taking £20,000 in dividend payments, then you would pay 33.75% on £18,000 of dividends. This would result in a Dividend Tax bill of £6,075, up £225 from the current system.
How the increase to Dividend Tax will affect the effective tax rates
Recently, FTAdviser published some useful figures comparing the effective tax rates business owners and directors pay on dividends and salary.
In the 2021/22 tax year, the effective rate of tax when taking a dividend or salary from a company is:
As you can see, the effective rate of tax is slightly lower for dividends. So, it’s no surprise that most owner-managers take a small salary to utilise the National Insurance nil-rate band and Personal Allowance, and then take additional sums as dividends.
So, how will this position change when the tax rate rises in 2022/23?
From April 2022, the differential between dividends and salaries will grow further. So, assuming your business is in a practical position to pay dividends it looks as if the preferred remuneration strategy will continue to be appropriate.
A useful alternative to taking salary and/or dividends
While dividends might continue to be a preferred remuneration option, rising effective tax rates may encourage you to consider alternative methods of extracting money from your company.
One such way is by making pension contributions. Currently contributions to personal pension plans can be made by companies for business owners. Any employer pension contributions made “wholly and exclusively for the purposes of the business” can receive both Corporation Tax and National Insurance relief.
In 2021/22 that is a 13.8% National Insurance saving, which you could redirect to your pension pot. This will rise to 15.05% from 2022/23 when employer National Insurance rates rise.
And, with Corporation Tax set to rise sharply for many businesses from April 2023, there could be even more convincing reasons to consider this approach.
Before you do this, you must acknowledge that putting money into your pension means you are unlikely to be able to access these funds for several years. You ordinarily can’t draw from your pension until age 55 (rising to age 57 in 2028) and so you have to accept that this money is committed for the future.
Get in touch
If you have any queries about how using a pension could help you tackle the Dividend Tax rise, please get in touch. Please email firstname.lastname@example.org or call 01454 416 653 to find out more.