The chancellor's Budget 2025 announcement of a 2 percentage point increase to dividend tax from April 6th 2026, is yet another kick in the teeth to the UK's flexible workers — contractors and the owners of small, project-based companies.
It is Personal Service Company (PSC) directors who take on commercial risk, without the cushions of employment protection and status, who will bear the brunt of this 2p dividend tax increase, as HM Treasury finds an easy source of politically popular revenue.
Dividend tax increase: How much extra cost per contractor to HMRC?
The figures showing the impact of the dividend tax increase on PSC contractors are straightforward to work out, writes Michael McCullion, managing director of Bright Ideas Accountancy, an accountancy firm specialising in contractor taxation.
Suppose a contractor takes around £100,000 a year through the usual structure of low salary and the rest as dividends. In that case, the 2% points dividend tax increase equates to roughly £1,739 extra per year, every year, to HMRC — and into the future (assuming such a contractor continues to extract the same amount of income).
What are the April 2026 dividend tax increases?
The dividend tax hikes are:
- A two percentage points uplift from the current basic rate of 8.75% to 10.75%, and
- A two percentage points uplift from the current higher rate band from 33.75% to 35.75%
The new rates are effective from tax year 2026-27, commencing April 6th 2026, at which point the current tax-free dividend allowance for 2025-26 — £500 — will apply.
Unfortunately for the bottom line of small, agile, project-based companies, due to how contractors remunerate themselves, the new rates of income tax applicable to dividends will affect a significant portion of their income.
The dividend tax increases follow three other squeezes on PSC contractors
- The reduction of the dividend allowance from £5,000 to £2,000, to its current £500;
- Years of frozen tax thresholds in real terms, pulling more contractors into higher tax bands, and
- The increased complexity and cost of compliance of IR35 reforms.
In this context, the two percentage point dividend tax increase of 2026 is unlikely to be considered in isolation.
Indeed, the increases appear to be merely the latest in a series of adjustments over multiple years, which continue to pull the effective tax position of PSC owners into line with or even in some cases above what employees pay to HMRC. All the while, though, such PSC contractors take on business risk yet receive no employment protections.
Can PSC directors mitigate the dividend tax increase?
As to any realistic steps that a director of their own limited company can take to mitigate the impact of the dividend tax increase, unsurprisingly, there is very little scope to act.
Unlike some areas of taxation, dividends are extremely formulaic. Once you declare them, you receive and pay tax on them in the year that they are received. This is in contrast to many other sources of income, where deferral strategies, income spreading or other mechanisms are available.
This means that, realistically, there are only two genuine areas of tax planning or leverage for contractors facing the 2% percentage points dividend increase.
1. Accelerate dividends before April 2026
Contractors who were already planning to take profits in the next 12-18 months should now consider whether to bring that distribution forward.
In most cases, the benefit is clear. The additional two percentage points apply from the 2026/27 year onwards, not before. Therefore, this could be up to £1,700 saved in the first year dividends are taken.
However, it is highly likely that contractors will have already utilised the rate bands for dividends in the current year.
2. Review whether a higher salary becomes more efficient
The general answer as to whether the chancellor using Budget 2025 to make dividends more taxing makes director salary more attractive is, a bit awkwardly for those who want simple solutions, only in some specific circumstances.
For contractors operating as a single-director company, salary will remain largely tax inefficient due to employer NICs. But in cases where there are multiple company employees, the Employment Allowance of up to £10,500 of employer-NIC-offset can kick in, which makes a higher salary at least slightly more efficient. Be aware, it will not bridge the £1,700 gap that has opened, but it will move the optimal salary-dividend split slightly towards salary in some cases.
Beyond these two, there are not many planning options left to play with for limited company contractors who remunerate themselves using dividends. Pension contributions remain attractive, and appear (at least for now) to be unaffected by the new salary sacrifice clampdown, which is due to apply from 2029. However, those contractors who find themselves 'inside IR35' will feel the pain of the salary sacrifice raid.
Has the chancellor opened the door to further dividend tax hikes?
In my view, yes, the door has now been opened to further hikes in dividend taxation — and quite deliberately.
The political message of the chancellor's move is that dividend income is somehow 'under-taxed' relative to employment income. The second aspect of the message seems to be that 'the wealthy' are able to disproportionately benefit from lower taxes on dividends.
This two-fold message completely ignores the practical reality that the overwhelming majority of dividend taxpayers affected by the April 2026 increase are not wealthy portfolio investors, but ordinary working contractors operating their own small, limited company.
Once the intellectual position has been established that dividend taxation can and should go up, it becomes far easier for a future budget to build on the 10.75% and 35.75% basic and higher rate bands, respectively.
A trajectory has now been established. Limited company contractors will be right to be concerned that the extra 2% on dividends from 2026-27 will not be the last increase that deprives them of more of their income.
TL;DR: How 2% more on dividends affects limited company contractors
The April 2026 dividend tax increase is yet another tightening of the screws on the UK's contracting population.
With very limited scope to plan around or reduce a potentially £1,739 more per year in dividend taxes to HMRC, contractors are faced with paying more, while having already absorbed increased compliance costs and the removal of their planning reliefs.
For limited company directors, the only two mitigation options — accelerating dividends ahead of April 2026 and reassessing whether salary becomes more efficient where the Employment Allowance is available — offer limited help at the margin.
The wider concern is that the chancellor's two percentage point increase may be the prelude to further dividend tax increases in future, and that's a very concerning sign for owner-managed companies which remain at the engine room of the flexibility and productivity of the UK economy.
