Dividends have long-been a nice bonus for shareholders and also for self-employed limited company directors to withdraw payments from their business tax-efficiently.

But a reduction in tax-free allowances for dividend payments in recent years has been gradually eroding the benefits of them.

With the chancellor Rachel Reeves keen to balance the nation’s finances, there are also fears that dividend tax could be next for the chancellor to fiddle with. Here is what you need to know about dividend tax

What are dividends?

Dividends are payments that companies make to their shareholders on a regular basis, typically annually or quarterly.

The level of dividend payments will often depend on the company’s profits.

There are two ways that people could receive dividends:

It is seen as more tax efficient than just taking a salary as dividend tax is lower than income tax. Many self-employed people will combine a salary and dividends from their limited company to keep their tax bill down.

How much is dividend tax?

As with any income, there may of course be tax to pay HMRC. There is however a dividend allowance, which lets investors or company directors take a certain amount of payments tax-free.

The allowance was £5,000 as recently as 2016 but has been falling in recent years from £2,000 in the 2022/23 tax year to £1,000 in the 2023/24 tax year. It is now just £500.

Any earnings above this are charged at 8.75 per cent if all your income – dividends, salary and other earnings combined – makes you a basic rate taxpayer, 33.75 per cent for higher rate taxpayers and 39.35 per cent for additional rate taxpayers.

The two tables below show the changes and breakdown:

Dividend tax rates and thresholds are not currently set to change for 2025/26.

Michelle Lawson, director at Lawson Financial, said: “The dividend tax has been increasing year on year making it less attractive not only to invest but to also be self-employed in the UK. Investors want to see a return on their money but if wanting to draw on this it is becoming more costly to do so.

Get a free fractional share worth up to £100.
Capital at risk.

Terms and conditions apply.

Go to website

Get a free fractional share worth up to £100.
Capital at risk.

Terms and conditions apply.

Go to website

“If you are self-employed as a limited company director, the relentless taxation is making the costs spiral upwards which have to be passed on to the end consumer.”

Will the chancellor raise dividend tax?

In contrast to dividends, income tax is charged at 20 per cent at the basic rate, 40 per cent for higher rate taxpayers and 45 per cent on the additional rate.

So it is easy to see why Reeves may be tempted to generate more cash from dividends.

Gabriel McKeown, head of macroeconomics at Sad Rabbit, said: “With the public finances remaining under significant strain and economic growth struggling to gain traction, it is conceivable that the Treasury will continue to view dividend taxation as a relatively low-resistance means of raising revenue.

“Of course, outright alignment with income tax rates would likely trigger a significant political backlash, yet further reductions in allowances and incremental increases in tax rates could be seen as a more politically palatable approach.

“However, favourable dividend taxation has historically been framed within a broader economic strategy, seeking to encourage participation in capital markets, yet with London’s markets already struggling to attract investors, this policy risks the UK losing even more ground to international competitors.”

There are plenty of benefits to receiving dividends if you are run your own limited company.

Dividends are taxed at a lower rate than earned income or interest and there’s also no employer’s national insurance liability, which can make it an efficient way to draw money from a business.

But Ross Lacey, director at Fairview Financial Management, highlights that dividends can only be paid from profits, so for a company, this means what’s left after corporation tax has been paid.

He added: “There’s an optimal blend of salary and dividends that will be specific to the company set up, how many directors, and the level of drawings desired, so it’s always wise to lean on an accountant for advice in this area.”

open image in gallery

If you went back in time to around ten years ago, then beyond paying a small salary it was almost always better for director-shareholders of limited companies to pay themselves by dividends. 

Analysis by accountancy firm Forbes Dawson in 2015 found higher and additional tax rate payers could save up to nine per cent in tax by taking additional profits out as dividends as opposed to salary. This was due to a combination of low corporation tax rates, and lower tax rates on dividends compared with earned income.

These benefits started to be eroded when then-chancellor George Osborne hiked an extra 7.5 per cent onto dividend tax from April 2016. Initially, this was balanced with a £5,000 tax free dividend allowance but this has been gradually eroded while corporation tax has increased.

Tom Minnikin, partner at specialist tax consultancy Forbes Dawson, said: “The combination of all these changes has left us in the unprecedented position where, beyond basic rates, business owners pay a higher marginal rate of tax on their dividends than they would pay on a salary.

“The differences may be small, but the psychological impact on business owners – who potentially now find themselves paying higher marginal rates of tax than their employees – is huge.”

Is it worth taking dividend payments?

Despite dividend tax changes, research by Forbes Dawson suggests that unless business owners need to extract very large amounts of profits from their limited company – taking dividends remains among the most tax efficient.

Minnikin added: “For an individual with £100,000 of profits, we estimate that they will still save around £5,000 per annum compared to taking all profits as salary by structuring their remuneration in this way. The saving arises mainly from the fact that dividends are only charged to 8.75 per cent tax within the basic rate band.”

He adds that while it is possible that Reeves might look to generate more revenue by increasing dividend taxes further, it is difficult to see how this will promote growth in the economy, adding: “There needs to be some incentive for entrepreneurial individuals to take risk by starting a business.”

When investing, your capital is at risk and you may get back less than invested. Past performance doesn’t guarantee future results.