Dividend allowance – the first big cut

From 6 April 2023, the annual tax-free dividend allowance was halved from £2,000 to £1,000. This is the first of two planned cuts, with the allowance set to fall further to £500 in April 2024.

For director-shareholders who typically take a low salary and high dividends, this change means more of their income will be subject to tax. Now is the time to review your profit extraction strategy to ensure it remains as tax-efficient as possible.

The immediate cost

For a basic rate taxpayer, the loss of £1,000 of the allowance means an additional £87.50 in tax per year. For a higher rate taxpayer, the cost is £337.50, and for an additional rate taxpayer, it is £393.50. While this may not seem like a massive amount in isolation, it comes at a time when Corporation Tax rates are also rising, squeezing the overall returns for business owners.

Reviewing remuneration

With the dividend allowance shrinking, business owners should consider whether other forms of remuneration are more appropriate. For example, the company could make increased employer pension contributions on the director's behalf. These contributions are typically an allowable expense for Corporation Tax and do not trigger an immediate Income Tax or National Insurance liability for the individual.

Using alternative wrappers

For investors with share portfolios outside of their own companies, the cut to the dividend allowance highlights the importance of using tax-free wrappers. Moving investments into an ISA can shield the generated dividends from tax entirely, ensuring that the reduction in the allowance does not impact your net investment returns.