Dividend tax rates increase: what you need to know so you can plan ahead.
Next year, on 6th April 2023, the Government will introduce a new health and social care levy (HSCL), intended to provide ring-fenced funding for health care (including adult social care). If you make National Insurance contributions (NICs), and haven’t reached state pension age yet, then you’ll be paying for the HSCL too, as the two are directly linked. If you don’t pay National Insurance, you won’t need to pay the HSCL.
So what does this mean for people who typically take a small salary plus dividends from their business to be more tax-efficient? Normally they would take a salary in line with the lower earnings limit for primary Class 1 NICS and not more than the primary threshold, which for 2021/22 would be £9,568 when the employment allowance isn’t available (eg a personal company where the sole employee is also the director). If the employment allowance is available, the personal allowance increases to £12,570.
Usually, this would give you an advantage in that little or no NICs are payable, which would mean that when the HSCL is introduced next year, there would be little or no liability there either. However, this has been addressed by the Government to even things out and make sure that people taking dividends instead of a salary also make a meaningful contribution to health and social care costs.
They’ve done this by increasing dividend tax by 1.25%, which is the same amount as the HSCL, and this increase takes effect from 6 April 2022. So whilst this is a year before the HSCL begins, it’s the same time as a temporary increase for Class 1 NICS (also set at 1.25) for 2022/23.
If you primarily extract your profits as described above (small salary plus dividends), then there’s still an opportunity to beat these tax rises when it comes to your 2021/22 profit extraction policy.
Dividend tax rates
Everyone has a dividend allowance on top of their personal allowance, which is set at £2000 for 2021/22, but they’re taxed at different rates, which will increase for 2022/23:
In real monetary terms, this means that if you follow the same profit extraction policy in 2022/23 as you had for 2021/22, for every £10,000 of dividends paid over the dividend and personal allowances, you will pay an additional £125 in tax.
So should you take your dividends before 6 April 2022? Because dividends are paid out of your retained profits (ie profits which have already had corporation tax paid on them), you can only pay a dividend if there is enough in the pot to pay it.
If there are enough retained profits, you might consider paying further dividends ahead of April 2022, so that you can take advantage of the lower tax rates. Do consider though whether that will take the dividends into a higher tax bracket (thus negating the tax-saving benefits).
So how would this look in a real-world scenario? Consider the below examples:
Study 1: Accelerated dividend
Jane provides services through a personal company. She pays herself a salary of £9,568 for 2021/22, and plans to take £15,000 in dividends.
Applying this strategy gives Jane a total income of £24,568, which will use up £11,998 of her basic rate band (i.e., £24,568 – £12,570), leaving £25,702 available.
After allowing for the planned dividends of £15,000 for 2021/22, Jane still has £20,000 of retained profits remaining. She expects to make a further £30,000 of retained profits next year and is intending to apply the same profit extraction strategy as in 2021/22.
If Jane takes the remaining £20,000 in 2021/22, she’ll pay tax at the 2021/22 ordinary rate of 7.5%. Taking these profits after 6 April 2022 in addition to her normal salary and dividend means she will pay tax at 8.75%. Therefore, taking them before 6 April 2022 could save Jane £250 in tax.
Study 2: Which tax year?
Beni has an income of £14,000 a year from property rental, which utilises his personal allowance. He also has a personal company and extracts profits from this solely as dividends.
In 2021/22, he has taken £35,000 of dividends. After taking these, there is £25,000 of retained profits left over. He would like to cut back on his working house and so expects his profits to fall to £10,000 after tax in 2022/23.
As Beni has used up £36,430 of his basic rate band for 2021/22, he has a further £1,270 available. He could take this as dividends in 2021/22 to take advantage of the 7.5% ordinary dividend rate applying for 2021/22, but any further dividends taken in 2021/22 will be taxed at the dividend upper rate of 32.5%.
While the dividend rates will be higher in 2022/23, Beni will most likely have a lower income, so may be better off if he takes the remaining £23,730 of retained profits after 5 April 2022.
If he waits until 2022/23, along with the expected profits of £10,000, the dividends would fall within the basic rate band and be taxed at the dividend ordinary rate of 8.75%, which is lower than the upper dividend tax rate of 32.5% applying for 2021/22, meaning that by waiting, Beni will ultimately pay less tax by taking the profits in 2022/23.
Not sure what would work best for you? Get in touch and see how we can help!