The UK government is following through with plans to increase both National Insurance (NI) and dividend tax from 6 April 2022. From the new tax year onwards, both NI and dividend increases are expected with tax seeing an increase of 1.25%
Much has been said about the impact that this tax increase has on the employed and self-employed. Along with increased living costs and energy prices, the tax increase has been met with understandable criticism as many families struggle with economic hardship
However, the impact that the tax dividend increase will have on small business owners trading as limited companies is being overlooked. Let’s take a closer look at the impact of the impending dividend tax increase and considerations business owners should be making:
Dividend Tax Increase Overview
As mentioned, dividend tax is set to increase by 1.25% from 6 April 2022. The new increase means dividend tax rates are now:
- 8.75% for basic rate tax
- 33.75% for higher rate tax
- 39.35% for additional rate tax
The dividend allowance has not changed, meaning no income tax is charged for an initial £2,000 dividend.
Impact on the Dividend Salary Package Method
While this tax increase has caused some headaches for directors of limited companies, the method of a small salary and large dividends still offers the best tax incentives. This is especially true if the basic tax rate band of £50,270 is not yet met.
Furthermore, the new increase may give rise to an immediate cash extraction method. For example, directors may opt to take dividends before the new tax increase comes into effect on 6 April 2022. This method would take advantage of the lower tax rate while it remains available.
Of course, the amount withdrawn depends on the unique situation of each company. Regardless, providing that the dividend is being paid prior to the upcoming tax year, there is likely potential for huge tax savings.
Conversely, holding off on dividend withdrawal may be the better strategy. This strategy would be more beneficial if the director’s current tax rate is too high. Holding off until their tax rate is lower may see less taxes paid by keeping it within the basic band.
Understanding Dividend Restrictions
There are restrictions in place where the company may not be able to pay a dividend, impacting the dividend salary method many owners use. For example, if the company has not made enough profits after corporation tax, then it cannot pay dividends.
However, there are instances where a dividend payment is possible even when losses were made. For instance, bringing retained profits forward, providing their amount is enough to cover the dividend.
Understanding the restrictions and the impact this has on the salary dividend method is important to ensure the best decision is made.
Dividend Tax Increases – Things to Consider for the Future
If an owner is planning to sell the company in the near future, then it may be worth holding off on a larger dividend withdrawal before the tax increase. While taking a larger dividend may be appealing due to the protentional savings before the tax increase, doing so will influence the selling price.
So, if there are plans to sell soon, then deferring dividends withdrawals may prove a better strategy. In the right circumstances, deferring withdrawals prior to winding up is a more efficient strategy, as the money is changed to capital gains tax as opposed to income tax.
Voting for additional dividends may not be an ideal strategy if the company lacks funds due to lower profits from Covid-19. Many companies simply cannot pay the same level of dividends due to lower profits due to the impact of the pandemic.
Therefore, if a company is using overdrawn accounts rather than profits to pay dividends, then it may come with a higher dividend rate of 32.75%. Unless the profits are there to pay the dividends, then voting for dividend withdrawal may not be the most tax-efficient strategy.