Contractors, are you ready for £500 less in dividend allowance?

As a limited company contractor in receipt of dividends, you only pay tax on any dividend income above the dividend allowance -- even if that allowance is reducing on April 5th 2024. 

Before we look at what amounts to a hefty 50% reduction, keep in mind that a dividend is a distribution of profit after tax, by a company to its shareholders.  

For the purpose of this look at dividends in 2024-25 through a contractor lens, I will assume that your limited company has one shareholder and if you are the only shareholder, you will receive 100% of the available retained profit, writes chartered certified accountant Teodora Dimitrova, owner of Chart Accountancy.  

Dividends: the basics 

Dividends in the UK are not subject to withholding tax when paid by the company to its shareholders. Therefore, dividends are paid gross from the company to its shareholders.  

You'll need to declare the total dividend income you've received on your Self-Assessment tax return for each tax year ending April 5th. The deadline for an online submission to HMRC is by January 31st following the end of the tax year. Or if you’re doing a paper tax return, you must submit to HMRC it by October 31st.  

Dividends are (still) among the benefits of limited company contracting 

There are a number of advantages to being a limited company contractor, also known as a Personal Service Company contractor, such as a higher rate of pay.  

Another key advantage is the potential tax-saving because you can receive dividends tax-free.  

In fact, you do not pay tax on any dividend income that falls within your Personal Allowance (PA). The standard PA (at the time of writing) is £12,570.  

Dividend tax-free dividend allowance in 2024-25, explained

You also get a ‘dividend allowance’ each year -- and I introduced this at the top.  

Crucially, you only pay tax on any dividend income above the dividend allowance.  

For the current 2023/24 tax year, ending April 5th 2024, the dividend allowance is £1,000.  

But this allowance will reduce to just £500 from the new tax year – that’s 2024/25, starting on April 6th 2024.  

In contrast, the PA and basic rate limit will be fixed at their current levels -- up to and including the 2027-2028 tax year. In fact, HMRC says the government has set the PA at £12,570, and the basic rate limit at £37,700, for future tax years.

More contractors than ever taxed at 45%?

But that ‘advantage’ I mentioned of earning more as a contractor, is a bit of a double-edged sword. 

Since April 6th 2023, you are categorised as a top earner taxed at 45% if your income is above £125,140 (this threshold has been reduced from £150,000 in the 2022-23 tax year).

As a result, contractors earning in excess of £150,000 will pay £1,243 more a year in tax for their income between £125,140 and £150,000, because this is the new ‘additional rate’ at 45%, up from 40% previously. 

The above thresholds were confirmed at the Autumn Statement 2022 on November 17th and unfortunately for some, they weren’t reversed at Autumn Statement 2023 on November 22nd!

Autumn Statement 2022 refresher

But also at Autumn Statement 2022, the government announced a number of personal tax-related thresholds to say they are reduced or frozen, notably:  

1) Income tax ‘additional rate’ threshold cut from £150,000 to £125,140 on April 6th 2023.  

2) PA and basic rate limit threshold frozen for a further two years until April 2028.  

3) Dividend ‘nil-rate’ band reduced from £2,000 to £1,000 on April 6th 2023 and reduced to £500 from April 6th 2024.  

4) Annual exempt amount for capital gains tax to be reduced from £12,300 to £6,000 on April 6th 2023, and reduced to £3,000 from April 6th 2024. (N.B. Automatic inflationary increases will no longer apply.)  

Direction of travel

I’ve mentioned Autumn Statement 2022 quite a bit, above, as I think it’s helpful to see the direction of travel which the government has been going in. 

And continues to go in. 

Out of the above four AS 22 announcements, it’s the third reduction -- a halving in the tax-free dividend allowance -- which will affect the greatest number of contractors, and soon. 

Dividend tax thresholds 2024-25

For reference, the current tax thresholds for dividends are as follows:  

• Basic rate (taxed at 8.75%): up to £50,270 including your Personal Allowance;  

• Higher rate (taxed at 33.75%): from £50,271 to £125,140;  

• Additional rate (taxed at 39.35%): over £125,140. 

To determine which threshold applies, you must include all sources of income, i.e. not only from your limited company, so you will need to include your director’s salary, any other personal income such as from a rental property, bank interest, and foreign income (if applicable).

Also, monitor the amount of interest you receive from any personal savings accounts because you don’t want it to eat into your basic rate threshold allowance available to allocate to your dividends. 

Regressive tax measures 

The government’s decision at AS ’22 and ’23 not to increase the PA and basic rate threshold by at least by the rate of inflation, coupled with reduction of the additional rate threshold, is a harsh decision which will result in a fiscal drag. 

But what is fiscal drag & stealth tax? Freezing tax thresholds (as the current chancellor appears to like to do) increases people’s taxable income without nominal tax rates actually increasing. This results in additional revenue to the government. This is called ‘fiscal drag’, as more taxpayers are ‘dragged’ into paying tax, or into paying tax at a higher rate.  

Since freezing thresholds raises overall tax revenue without taxes actually increasing, the policy has also been branded as a “stealth tax”  

Spring Budget 2024; action on dividends?

The chancellor has announced that Spring Budget 2024 will take place on March 6th 2024.  

With only £500 left as dividend allowance, will Jeremy Hunt go further in the direction he’s already travelled in, and restrict your tax-free allowance further, to just £250? Or in a boost to the enterprise community who he’ll want on-side at general election 2024, might he put the allowance back up to its original £5,000 (2017-18)? 

Whether they affect dividends or not, my hope is that the government will have a little more headroom to diarise if not introduce some tax cuts on March 6th, potentially encouraged by inflation of 3.9% in the 12 months to November 2023, down from 4.6% in October. The only certainty? We will have to wait and see.