Dividend allowance cut again: 3 million investors paying tax for the first time – is it still worth drawing dividends from a UK company?
- TBA
- Sep 25
- 4 min read
One of the main advantages of setting up a limited company in the UK is that shareholders can receive income through dividends.
Compared with salary, dividends are taxed at lower rates, which can reduce overall personal tax liabilities.
For example, in the 2024/25 tax year, each shareholder benefits from a £500 dividend allowance. Beyond this, dividend income is taxed according to the individual’s income tax band, at 8.75%, 33.75% or 39.35%.
This means that once income exceeds the personal allowance (£12,570) but remains within the basic rate band, dividends are the most tax-efficient option. Salary above the allowance is taxed at 20%, while dividends are taxed at only 8.75%. Even at the higher rate, dividends are taxed at 33.75% compared to 40% on salary.
More ordinary investors now paying dividend tax
With the start of the 2025/26 tax year, the dividend allowance has been reduced again, bringing many investors into the scope of dividend taxation for the first time.
According to the latest figures, an estimated 3.7 million people will pay dividend tax in 2024/25, compared with 1.9 million in 2022/23. For the first time, basic rate taxpayers now account for the majority of those affected. This marks a significant shift, drawing more ordinary investors and middle-income households into dividend taxation..
Should company directors take salary or dividends?
For company directors and owners, the shrinking allowance raises the familiar question: salary or dividends?
The personal allowance is £12,570, but salary beyond that is taxed at higher rates. Dividends have only a £500 allowance, yet are still taxed at lower rates.
Many directors adopt a mixed approach of ‘reasonable salary plus dividends’ to minimise their overall tax burden. A common strategy is:
Set salary within the personal allowance (£12,570) to preserve National Insurance contribution records.
Withdraw remaining profits as dividends, which are taxed at lower rates and avoid National Insurance.
Example
Suppose a company has profits and the director wishes to extract £20,000 as personal income.
Option 1: salary only
Salary: £20,000
Taxable amount: £20,000 – £12,570 = £7,430
Income tax: £7,430 × 20% = £1,486
National Insurance: approx. £289
Total tax: ~£1,775
Option 2: salary + dividends
Salary: £12,570 (tax-free)
Dividends: £7,430
Dividend allowance: £500 → taxable dividends: £6,930
Dividend tax: £6,930 × 8.75% = £606
No National Insurance
Total tax: ~£606
This shows savings of around £1,169 compared with salary-only extraction, plus no National Insurance liability.
Dividend tax also affects non-directors
Dividend tax is not only a concern for company directors. If you invest in shares or funds that distribute dividends, you may also be affected.
Holding shares directly
If you hold shares directly, all dividends you receive – whether reinvested or taken as cash – are treated as taxable income.
With only a £500 allowance, any dividends above this threshold are taxed at the following rates:
Basic rate: 8.75%
Higher rate: 33.75%
Additional rate: 39.35%
For example, if you receive £1,500 in dividends in a tax year, £500 is tax-free. The remaining £1,000 is taxed at 8.75%, resulting in a £87.50 tax bill..
Tax-efficient accounts
Dividends received within an Individual Savings Account (ISA) or pension (such as a SIPP) are completely tax-free and do not need to be reported to HMRC. This is one of the most effective tax planning strategies for UK investors. Note, however, that the ISA subscription limit for 2025/26 remains £20,000.
For investments held outside ISAs and pensions, such as funds, dividend tax may still apply.
Funds are usually categorised as ‘accumulation’ (Acc) or ‘income’ (Inc).
Income funds: dividends are paid directly into your account and count as taxable income in that tax year.
Accumulation funds: dividends are automatically reinvested, but HMRC still treats them as income for tax purposes. Annual tax statements from your investment platform will show the relevant figures.
How to report dividend tax
If you receive dividends above the allowance, you must report them to HMRC. The reporting method depends on the total dividend income.
Up to £500: no need to report to HMRC.
Between £500 and £10,000: you do not need to file a Self Assessment return. HMRC can adjust your tax code through PAYE, or you can report the income by calling HMRC.
£10,000 or more: you must file a Self Assessment tax return, declaring all dividend income.
If you have not previously registered for Self Assessment, you must do so by 5 October following the end of the tax year, with the return and any tax due payable by 31 January.
The view from TB Accountants
With the dividend allowance shrinking year by year, more investors are finding themselves paying dividend tax.
Effective tax planning and portfolio management are essential to reduce the impact and protect your investment returns.
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