The chancellor's replies to the Treasury Select Committee on Wednesday December 10th, in answer to questions about Budget 2025, will do little to allay contractors' fears that Rachel Reeves is going to raid dividends even further.
Asked if she thought that there was "space for more narrowing of the gap" between the tax on income from assets and income from work, Ms Reeves didn't directly answer the question, writes a chartered accountant with 40 years of professional experience, Anthony Mellor, founder of ICAEW member firm Mellor & Co.
The dividend tax increase, in the chancellor's own words…
Instead, Reeves told the committee that her November 26th announcement of a 2% points increase on the basic and higher dividend tax bands was the "right thing to do"; that it is "quite a big increase" (effective from 2026/27), and that she thinks "we got the balance right."
The chancellor also said: "Well, obviously if you go out to work, you pay national insurance, and you don't pay national insurance on other forms of income. But we have taken action in this budget to narrow the gap between those different forms of income."
Let me translate for readers of ContractorUK.
When Reeves says (as she did in her Budget speech) that this government is "narrowing the gap between tax on income from assets and income from work," what she actually means is simple — that she is taking more money off people who were daft enough to build their own business.
The 2% dividend tax increase officialises contractors as a target
To reiterate, the chancellor's change to dividends is a two-percentage-point hike on payments to HMRC from April 6th 2026.
The measure will raise around £1.2billion a year.
For that modest sum, Reeves has signalled that small company owners and contractor‑run limited companies are now an officially acceptable target.
Self-employed 'tax gap'? No, it's a benefits gap
Contractors probably saw a certain think‑tank's line before the budget: the self‑employed supposedly enjoy a 55% "tax discount" compared to employees on the same gross pay.
The Resolution Foundation, where one of the architects of the Reeves' Budget worked until only very recently, has been pushing that number hard. The "55%" claim makes a neat chart if you ignore what employees actually get for their money.
It also plays beautifully to a certain type of jealous, 9-to-5, conventional employee who sees a dividend and assumes, dear contractor, that you're 'getting away with it' — without ever pricing in the benefits that they take for granted.
Working people don't draw dividends, or so Reeves just said…
And that creates a dividing line that the chancellor is drawing.
To MPs on the Treasury Select Committee this week, Reeves said:
"In the end, because of the decisions we made on higher value council tax, property, dividends and a number of other measures, we were able to keep the contribution from working people as low as we possibly could."
What employees get that contractors don't
Employees don't just get a payslip. They also receive:
- Paid holidays;
- Employer pension contributions;
- Sick pay
- Assorted insurances and perks.
Put a sensible value on that package, which also includes maternity/paternity leave, and you arrive at something like 16–25% of salary.
On top of that, both the short and long-term risks sit with the self‑employed, not the employee.
What do I mean by short and long-term risks of self-employment?
Well, most employees never have to stare at the possibility of losing their house because a customer doesn't pay. Before limited liability, that really was the shirt off one's back. The UK invented limited companies precisely to persuade people to take those risks and build the businesses that create jobs for the risk‑shy.
The self‑employed and so‑called Personal Service Company directors have to buy all of that out of their post‑tax income. Or they don't and go without. (N.B. 'PSC' is not a legal term, just an HMRC label with a 'tax dodger' whiff).
On top of that, the average self‑employed contractor already earns roughly 30% less than a comparable employee, reflecting volatility, unpaid admin and general business troughs.
They're not some vast army of disguised employees gaming the tax system.
The ministerial airbrushing of benefits and risk
So when ministers parrot the line 'that there is a big tax gap to close,' they are airbrushing out a much larger benefits gap and again that risk. There's no contractually liable end-of-month guaranteed salary if you're self-employed.
Despite the chancellor verging on it, one should not talk about 'fairness' in taxation while refusing to count the value of what employees get handed to them automatically.
It should also be factored in that many of those 9-to-5 jobs exist only because someone else took the risk in the first place. The irony is hard to miss, and of course, only business operators understand the very concept of the risks they are taking day in and day out.
Why dividend tax increases are a blunt weapon
For a contractor or any owner-director working through a limited company, dividends are not some form of exotic investment income.
Dividends are simply how you take home the profit that's left after running the business and paying corporation tax.
Those profits have already been taxed by HMRC — up to 25% at the company level. Taxing them again, on the way out, is double taxation. And that's something governments spent decades promising they wouldn't do.
The UK now has a near 66% effective tax rate on business profit
By the time a higher-rate taxpayer in business on their own account has paid corporation tax, income tax and NICs, their effective tax on business profit can already approach two-thirds.
Add another 2 percentage points on dividend tax and, for some higher‑rate shareholders, the Treasury's share of profit is now in that 66% region once everything is counted — before you even get to VAT, fuel duty and the rest.
Sorry, chancellor, but that is not 'levelling the playing field' with employees.
Rather, it is making business risk and responsibility look increasingly pointless, and thus it puts the country's wealth generation at risk. That isn't just naïve; it's reckless.
A stealth income tax rise by another name
If the UK state needs more money, the grown-up way to do it is to raise income tax and make the argument. Voters don't care about the manifesto — we never believed it in any case.
Reeves has chosen the same route as her Conservative predecessors: stealth.
Hammering dividends allows the Treasury to pretend that 'ordinary' workers are untouched, even though many now operate through PSCs, side-businesses, and family companies.
Spring fears of finishing the job in Q1 2026
The current fiscal hole is measured in the tens of billions.
Raiding dividends for about a billion a year is symbolically useful to Labour, not economically serious. Yet once you have sold the public on the idea that dividends are under-taxed rather than double-taxed, you have created the excuse to come back for another 2 percentage points later.
If the Resolution Foundation still thinks there is a gap in 2026, why wouldn't the chancellor be tempted to 'finish the job' in the spring?
What three actions can dividend recipients realistically take, ahead of 2% more?
There is no clever trick that can make the disastrous extra 2% on dividends disappear.
But there are some practical things contractors and small company owners should be thinking about now. They are threefold:
- Dividend timing. Bringing forward dividends into 2025/26, before the higher rates bite from 2026/27 on April 6th 2026, is an obvious move (subject to not pushing yourself into an even worse tax band).
- Mix of extraction. The classic salary-dividend mix needs revisiting. For some contractors, it will still make sense to favour dividends. For others, a slightly higher salary and slightly lower dividend may smooth the overall effective rate, bearing in mind where NI starts and whether you qualify for any Employment Allowance (one-person companies are not eligible). Don't kid yourself that shifting everything into rent or interest is a magic solution, though every bit will help. Remember, property and savings income are already scheduled for the same 2%-point hike, albeit from April 6th 2027.
- Use what still works. Company pension contributions (always wise and very effective); ISAs (especially if you've never bothered to invest in one before), and genuine business expenses (pay more attention to what qualifies), remain legitimate ways to reduce the slice that goes to the Exchequer.
If you are going to be punished for taking profit out, it becomes even more important to think about what you leave in — and where it is invested. And how you eventually extract it.
And finally, don't accept the nonsense rhetoric of this dividend raid, which is disastrous for the UK
The one thing I would beg enterprising individuals, commercial operators and small-company owners not to do is to internalise this 'You're all tax‑advantaged' nonsense.
You are using the rules as written and for the reasons they were written, to generate wealth and jobs for the country. You do not get paid holidays, you do not get an employer quietly dropping money into your pension every month, and you carry risks that most employees would not tolerate for five minutes. That is the trade-off.
By all means, adjust the timing and mix of your income to limit the damage from this dividend raid. But don't accept it when you're told this is about fairness. It's not. It's about a government hooked on stealth taxes, happy to trade long-term entrepreneurial damage for a short-term fillip. In short, it's disastrous for the UK and our nation's prospects.
Final thought
And for ContractorUK readers still asking if there's anything to be done beyond maxing out dividends before April 6th 2026 — there is, but it's called long-term planning on extraction, pensions and risk, not a once-a-Parliament panic every time the Treasury reidentifies PSCs as low-hanging fruit.
