Shareholders and directors hit by dividend tax rate rise

Since the pandemic began, it's easy to understand how incorporated business owners - many of whom are directors of their own limited companies - might have felt the Treasury was taking aim at them.

From the moment Rishi Sunak first announced economic support via the furlough scheme, the Chancellor spoke of finding a fair way to ensure everyone would pay equally to get the UK's finances back on track.

Some saw this as targeting those who pay lower income tax rates, because many directors take their earnings in dividends and pay lower National Insurance contribution rates because they are self-employed.

While much of the focus on the new 1.25% social care levy announced last week has been on whether it is fair to make younger people pay for the care of the elderly, there is growing anger about the treatment of directors, particularly after they were unable to claim through the furlough scheme.

Kitty Ussher, chief economist at the Institute of Directors, said:

"Incorporated sole traders and other owner-managers, who rely on dividend income, were the only group of workers that were not supported by the Government."

Now, directors and shareholders who receive dividends from a company's profits face an increase in tax on those dividends from next April.

Dividend tax increase

From 6 April 2022, dividend taxes will rise to 8.75% for basic-rate income taxpayers, 33.75% for those paying higher-rate tax, and 39.35% for additional-rate payers, on payments above a £2,000 tax-free dividend allowance.

The current rates of the dividend tax are 7.5% for basic-rate income taxpayers, 32.5% for those in the higher-tax of income tax band, and 38.1% for those in the additional-rate.

These rates have remained unchanged for more than a decade, since April 2010 in fact, although the dividends regime has undergone significant change during that time. Most recently, in April 2016, the annual dividend allowance was slashed from £5,000 to £2,000.

Around 40% of savers who hold dividend-paying investments outside of ISAs can expect to be hit with higher taxes from 2022/23, according to Government forecasts.

Higher-rate taxpayers are expected to pay £403 more in 2022/23, while the bill for those paying basic-rate income tax will rise by £150 on average next year.

Tax-planning options

Two options to beat the dividend tax hike, particularly for those who have money in dealing accounts, is to consider putting as much as possible into an ISA or a pension scheme before next April.

ISAs continue to offer a tax-efficient way to save, allowing individuals to put up to £20,000 a year into a tax-free wrapper. This means there's no income tax or capital gains tax liability if the investment grows.

Some customers might rush to use up their £20,000 ISA allowance before the higher dividend tax rates kick in from 6 April 2022, driven by the tax benefits of ISAs enabling them to shelter dividends from the tax hike.

Alternatively, utilising the annual pension allowance - worth £40,000 in 2021/22 - is another tax-efficient option, although it involves taking money out of the company or investment for future use.

When the time comes to take benefits after the age of 55 (rising to 57 in 2028), 25% is normally tax-free with the rest of the retirement income that exceeds the personal allowance taxed at an individual's marginal rate of income tax.

Get in touch for personal tax planning advice.

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