Dividend allowance cut – impact on shareholders

From April 2024, the tax-free dividend allowance was reduced from £1,000 to just £500. This follows a previous cut from £2,000, significantly increasing the tax burden on small business owners and investors.

For those who rely on dividends as a major part of their income, this change highlights the importance of reviewing your profit extraction strategy to ensure it remains the most tax-efficient option available.

The impact on director-shareholders

Many owner-managers extract profits from their limited companies using a combination of a low salary (to preserve National Insurance records) and dividends. The reduction in the dividend allowance means that more of this income is now subject to dividend tax. For a basic rate taxpayer, this means an extra £43.75 in tax per year; for a higher rate taxpayer, an extra £168.75; and for an additional rate taxpayer, an extra £196.75.

Investors with large portfolios

The cut also affects individuals with significant investments outside of tax-free wrappers like ISAs. If your investment portfolio generates more than £500 in dividends annually, you will now need to declare this to HMRC, either through a Self Assessment tax return or by asking HMRC to adjust your tax code.

Reviewing your strategy

In light of this change, business owners should review their remuneration strategies. Alternatives to dividends, such as increased employer pension contributions or utilising tax-efficient benefits in kind (like electric company cars), may offer better overall tax efficiency. It is essential to model these options based on your specific personal and corporate tax position.