and this is the linked article at the bottom of the previous posted article
There’s no escape – Britain’s entrepreneurs are forced to give away half the cash they generate
The tax rate on dividends is set to increase by two percentage points from April 2026 Credit:
Last week Money writer Rachel Wait examined some of the factors influencing whether it is better for a small business to be structured
as a company or to remain a sole trader.
If you are already operating as a company, however, you are probably considering the implications of the additional two percentage point tax rate to be applied on dividends from next year.
One of the issues that profitable private companies have to consider each year is whether to retain the profit in the business to fund future growth or whether some should be extracted for the owners. This is essentially a commercial decision.
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If you do want to take out some of the funds, there is a decision to be made about the most tax-efficient way of doing so.
The choice is typically between taking a bonus or a dividend, although making further pension contributions should also be considered.
Income tax is paid on bonuses through PAYE, together with employees’ National Insurance contributions (NICs) paid at 8pc between the £12,570 primary threshold and the £50,270 upper threshold – 2pc is charged above this. These amounts will not change next year.
The
tax rate on dividends, however, will increase by two points from April 2026: to 10.75pc within the basic rate band and to 35.75pc at the higher rate.
There will be no increase in the 39.35pc additional rate.
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You may wonder why dividends are taxed at such strange rates.
It goes back to 1997 when Gordon Brown decided to abolish advance
corporation tax so that he could remove the dividend tax credit as a way of raising an additional £5bn a year in tax from pension funds.
I would need a separate article to explain both the impact and the subsequent changes.
The tax position of the shareholders cannot be considered in isolation because the decision also depends on the rates of corporation tax paid by the company, and also the cost of employers’ NICs on bonuses.
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Bonuses paid reduce the profits of the company on which corporation tax is calculated. Companies pay employers’ NICs on bonuses, but these payments become a “tax allowable expense” for the company.
Corporation tax rates, which were
not changed in the Budget, apply at 19pc for profits up to £50,000 a year. The rate then increases to 26.5pc until £250,000, after which it stays at 25pc.
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The question many private company owners are now considering is whether, from next year, the changes announced in the Budget shifts the balance towards taking a bonus or a dividend.
Clearly, the increase in the tax rate makes dividends reactively less attractive, but there is still no single right answer on this. It depends on the tax position of the shareholders as well as the corporation tax rate paid by the company.
Is it better to take dividends or salary?
Example 1:
It may help to explain this with a simplified example.
Assume the company is wholly owned by John, who also works in the business. The company pays corporation tax at 19pc and John takes a regular salary of £30,000, which makes him a basic-rate taxpayer.
He is considering how to pay out a further £10,000. If he takes it as a bonus, the company will pay National Insurance at 15pc. This means that the bonus itself will be £8,696 with NI of £1,304.
His income tax on the bonus, at 20pc, will be £1,739, and employees’ NI at 8pc equates to £696. He therefore takes home £6,261 with £3,739 going in tax overall – giving an effective tax rate of 37.39pc.
If instead he had structured the payment as a dividend, the company would have first paid corporation tax of £1,900, leaving cash for a dividend of £8,100.
He would pay income tax on the dividend at 10.75pc (being £870), leaving him with £7,230 and an overall tax take of £2,770 and a tax rate of 27.7pc. Clearly John is better off with a dividend in this example.
Example 2:
Now suppose that John had been taking a regular salary of £60,000 so that he is a higher-rate taxpayer.
Taking a bonus would again give him £8,696. Income tax would then be £3,478, but NI at 2pc would only be £174. His take-home pay would be £5,044 and his overall tax rate would be 49.56pc.
A dividend taken instead would be taxed at 35.75%, but it would still leave his take-home pay at £5,204, and an overall tax rate of 47.96pc. The dividend route looks better – but not by much.
Example 3:
Now suppose that the company profits for tax purposes were £100,000, so that the corporation tax rate was 26.5pc. The tax position does not change in my example if taking a bonus, but it does increase the tax for the dividend alternative.
With a company tax rate of 26.5pc, the dividend available drops to £7,350. With income tax at 35.75pc, the overall tax cost increases to £5,728 – a combined tax rate of 57.28pc – leaving just £4,272 for John.
Every situation will be different and you need to work through the numbers.
My overall conclusion is that for smaller businesses, even with the additional two points, dividends are still likely to attract less tax. This changes, however, once company profits rise above £50,000, when a bonus will usually be preferable.
Inevitably, it is not as simple as that.
For example, the £50,000 threshold reduces where more than one company is involved.
In addition, remuneration is a key factor in working out the tax relief available on pension contributions. Since the tax on bonuses is collected through PAYE, the date the tax is payable will be earlier than the tax on dividends.
Also keep in mind that
HMRC have no powers to stop you transferring shares tax-free to your spouse or civil partner, which may save tax on any dividends.
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With the tax rate rising, in most cases you will want to pay a dividend (if that’s your plan) before 6 April next year.
HMRC will be aware that this is going to happen, and inspectors may ask to see evidence of when the dividend was paid. The rules on this are covered in the HMRC manuals at
SAIM5040.
Two important points arise. Where money passes from the company bank account to the individual before the tax year end, the issue is whether you can provide evidence to demonstrate that it is a dividend and not remuneration or a director’s loan.
I realise that smaller companies may not have regular board meetings with formal board minutes. This is, however, an occasion where it could be critical in any inquiry.
Where money is credited to a loan account, payment is only considered to be made when the money is unreservedly placed at the shareholder’s disposal and they have the power to draw upon it. This may all seem rather pedantic, but it is better to be prepared and avoid problems in an enquiry.
Technically, a dividend is paid when it becomes “due and payable”. With a final dividend that is when it is declared by the shareholders in a general meeting.
For an interim dividend, this is only when it is actually paid to the shareholder. That is because an interim dividend can be rescinded if it is unpaid.
Finally, I should mention a few other relevant items in the Budget.
The Chancellor announced that salary sacrifice arrangements to give enhanced pension contributions will only be effective in
saving NI up to £2,000 a year. That raises the question of what counts as a salary sacrifice.
With large companies, there will be formal employment contracts which should provide the necessary evidence. I am unsure, however, how this will be determined with smaller companies, although we may have some detailed rules on this before April 2029.
The Chancellor has decided to double penalties for late corporation tax returns from April 2026. The Government is also considering introducing new requirements that mean transactions between close companies and their shareholders must be reported to HMRC. It will publish a consultation in early 2026.
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There is a balance to be drawn between efficient compliance and the administrative impact that this can have on business.
I fear that regulation is winning. We need entrepreneurial people – who are prepared to work hard and take risks – to start and build up the businesses that generate our national wealth.
It is hardly an incentive for them to do so when in return the state now requires them to jump over
so many administrative hurdles – and allows them to keep barely half of what they generate.
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Mike Warburton was previously a tax director with accountants Grant Thornton and is now retired. His columns should not be taken as advice, or as a personal recommendation, but as a starting point for readers to undertake their own further research.
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