Budget 2025: Dividend tax increase

It was not too many years ago that dividend tax did not exist.

Extra tax on dividends was introduced on 6 April 2026, at a rate of 7.5% for basic rate taxpayers, although the first £5,000 of annual dividend income was tax free. Very shortly, we will have 10.75% dividend tax on dividend income over £500 pa.

In her Budget speech on 26 November 2025, the Chancellor announced a 2% increase in the rates of dividend tax for basic and higher rate taxpayers.

From 6 April 2026, the rates will increase from 8.75% to 10.75% for basic rate taxpayers and from 33.75% to 35.75% for higher rate taxpayers. Interestingly, the additional rate of dividend tax, paid by ‘45% taxpayers’, whose annual taxable income is over £125,140, will remain unchanged at 39.35%.

For tax efficiency, most business owners, and especially of small owner-managed limited companies, chose to pay themselves a small salary (around £10,000 pa) and take the balance of their company profits as dividends. Unless these owner-managers have income from other sources, their company dividends make up the majority of their taxable income to which the additional 2% dividend tax applies.

At a time when the UK needs to encourage growth in the economy, the last thing we really need is more tax on investment and entrepreneurship. While the headline main rates of income tax, of 20% and 40%, have not been increased, in reality owner-managed limited companies will experience an increase in the taxes on their income by 2%. This will clearly affect self-employed working people who chose, or are effectively forced, to trade through a limited company.

It should be remembered that the rates of dividend tax are lower than the main rates of income and corporation tax. Some people may see this as unfair and wrong. However, this is for a very good reason; dividends are paid out of business company profits that have already been subject to corporation tax.

Small companies pay corporation tax at 19% on the first £50,000 of annual profits, 26.5% on the next £200,000 of profits, and then any surplus profits at 25%. 

While business owners paying themselves dividends are the main target, the increase in dividend tax will also affect anyone who owns shares outside of an ISA or pension fund tax-free wrapper and receives dividend income.

What tax planning opportunities are open to you?

Declare higher dividends before 6 April 2026

If you have reserves of surplus accumulated profits sitting in your company, now may be the time to consider declaring higher dividends to take advantage of the current lower rates. However, do not increase dividends too much, so as to pushes your income into a higher tax bracket.

Disincorporate

Small owner-managed businesses may choose to disincorporate, and trade as a sole trader or through a partnership structure. The rate of Class 4 National Insurance is only 6%. When combined with 20% income tax, a basic rate taxpayer pays 26% ‘tax’ on their sole trader profits over £12,570 pa. 

However, a person operating through a limited company pays 19% corporation tax on their profits and will pay a further 10.75% on dividends drawn. The 10.75% dividend tax rate works out at 8.7% of pre-tax company profit i.e. 10.75% x (100% - 19%). Therefore, a basic rate owner-manager taxpayer pays 27.7% ‘tax’ on their company profits.

It should be noted that dividend tax is paid on amounts over £500 pa, unlike Class 4 National Insurance (paid by a sole trader) which is only paid on profits over £12,570 pa.  From a tax point of view, it now seems better to trade as a sole trader.

Transfer shares into an ISA

If you own listed company shares or unit trust style investment funds, that generate dividend income and capital growth, you may wish to transfer these shares / funds into an ISA.  You would have to sell the shares, pay capital gains tax on any capital gains over the £3,000 annual capital gains tax exemption, and then repurchasing them through a Stocks & Shares ISA. This process is also known as ‘Bed and ISA’. The process will ensure that future taxable dividends and capital gains are received tax free. With an annual ISA allowance of £20,000, it would take many years to move a modest share portfolio into a tax-free wrapper.

Use spouse and civil partner exemptions

Married couples and civil partners can use their two amounts of the annual dividend allowance (£500 each), two capital gains annual exemptions (£3,000 each) and two £20,000 annual ISA limits by transferring their investments between spouses tax free.  No capital gains tax is payable by couples moving their investments between themselves.