If you run your own limited company in the UK, you deal with two separate taxes on your business profits: corporation tax and dividend tax. Understanding how they interact is the difference between paying the right amount and paying more than you need to.
This article explains exactly how corporation tax and dividend tax work together for a limited company director in the 2025/26 tax year. We will cover the rates, the mechanics, and the practical planning decisions that affect how much tax you actually pay overall.
What Is Corporation Tax?
Corporation tax is the tax your limited company pays on its taxable profits. It is not a personal tax. The company pays it directly to HMRC, usually 9 months and 1 day after the end of its accounting period.
For the 2025/26 financial year (accounting periods starting on or after 1 April 2025), the rates are:
- 19% small profits rate: applies if your company's taxable profits are £50,000 or less.
- 25% main rate: applies if taxable profits exceed £250,000.
- Marginal relief: applies for profits between £50,000 and £250,000. The effective rate gradually increases from 19% to 25% across this band.
The thresholds are divided by the number of associated companies in the group. If you have two associated companies, the £50,000 threshold drops to £25,000 each.
What Is Dividend Tax?
Dividend tax is a personal tax paid by the individual shareholder who receives the dividend. Your limited company does not pay any tax when it distributes dividends. The tax falls on you personally.
For 2025/26, the dividend tax rates are:
- 8.75% basic rate: applies to dividend income within the basic rate band (£12,571 to £50,270).
- 33.75% higher rate: applies to dividend income within the higher rate band (£50,271 to £125,140).
- 39.35% additional rate: applies to dividend income above £125,140.
You also get a dividend allowance of £500 per tax year. The first £500 of dividend income is tax-free. Above that, the rates above apply. The allowance does not reduce your total income for the purposes of determining which tax band you are in.
How Corporation Tax and Dividend Tax Interact
Here is the key point many directors miss. Corporation tax is charged on the company's profits before dividends are paid. Dividend tax is charged on the individual's income after the company has paid its corporation tax.
This means the same profit is taxed twice. Once at the company level (corporation tax) and once at the personal level (dividend tax). This is called the imputation system. It is not double taxation in the strict sense because the two taxes apply to different legal entities. But for the director who owns the company, the combined effect matters enormously.
Let us look at a worked example to make this concrete.
Worked Example: A Single Director Company
Assume you are the sole director and shareholder of a limited company based in Manchester. Your company makes a profit of £80,000 in the 2025/26 accounting period. You want to extract all of it as a combination of salary and dividends.
Step 1: Corporation tax on the profit
Your company pays corporation tax at 19% on the first £50,000 and marginal relief on the remaining £30,000. The effective rate on £80,000 is approximately 21.25%. Corporation tax due: £17,000.
Profit after corporation tax: £63,000. This is the pool available for dividends.
Step 2: Taking a salary
You take a salary of £12,570 (the personal allowance). This is an expense for the company, so it reduces the corporation tax calculation slightly. For simplicity, we will assume the salary is already accounted for in the £80,000 profit figure. Your salary uses up your personal allowance, so no income tax is due on it. You also pay no employee NI because £12,570 is below the primary threshold.
Step 3: Taking dividends
You now take dividends from the remaining profit. You have £63,000 available. You decide to take £50,000 in dividends.
Your total personal income is £12,570 salary plus £50,000 dividends = £62,570.
Your personal allowance is already used by the salary. So the first £500 of dividends is tax-free (dividend allowance). The remaining £49,500 of dividends falls into your basic rate band (up to £50,270). The basic rate band is £50,270 minus the salary of £12,570 = £37,700 remaining. But your dividend allowance covers £500, so the taxable dividend in the basic rate band is £37,200 at 8.75% = £3,255.
The remaining dividend income (£49,500 - £37,200 = £12,300) falls into the higher rate band. Tax at 33.75% = £4,151.25.
Total dividend tax: £3,255 + £4,151.25 = £7,406.25.
Total tax paid
Corporation tax: £17,000. Dividend tax: £7,406.25. Total: £24,406.25 on £80,000 of profit. That is an effective combined rate of roughly 30.5%.
If you had taken the full £80,000 as salary instead, you would pay employee NI, employer NI, and income tax at your marginal rate. The combined rate would be higher. Dividends remain more tax-efficient for most directors, especially when the company is profitable.
Why the Order Matters
The order in which you take salary and dividends changes the tax outcome. Salary is an allowable expense for corporation tax purposes. Dividends are not. So taking a salary reduces the company's taxable profit and therefore its corporation tax bill. But salary also uses up your personal allowance and triggers employer NI.
The most common efficient structure for a director with one company is:
- Take a salary of £12,570 (matches the personal allowance and the primary NI threshold).
- Take dividends up to the top of the basic rate band (£50,270 total income, so dividends of £37,700 after the salary).
- Above that, dividends are taxed at 33.75%. At that point, the combined corporation tax and dividend tax rate on additional profit is approximately 25% (company) plus 33.75% (personal) on the post-tax profit. That works out to an effective combined rate of about 50% on the original profit.
For many directors, the optimal strategy is to keep total personal income within the basic rate band. That means drawing dividends of roughly £37,700 plus a salary of £12,570, giving a total of £50,270. Any additional profit stays in the company and is reinvested or retained for future extraction.
The Dividend Allowance Is Shrinking
The dividend allowance was £2,000 in 2022/23. It dropped to £1,000 in 2023/24 and then to £500 for 2024/25 onwards. That £500 allowance means the first £500 of dividends you receive each year is tax-free. But it is not a tax credit. It is a zero-rate band. And it does not reduce your total income for determining which tax band you are in.
If you have multiple shareholders (for example, you and your spouse each own shares), each of you gets a separate £500 allowance. That can be useful for couples running a business together.
What About Spouse Shareholding and Alphabet Shares?
Many husband-and-wife limited companies use alphabet shares to allocate dividends flexibly. For example, you might have A shares and your spouse has B shares. Each class of share can receive a different dividend. This allows you to keep both shareholders within the basic rate band.
But be careful with settlement legislation (often called "income shifting" rules). If shares are gifted to a non-spouse, HMRC may argue that the dividend income should be taxed on the original owner. For spouses, the rules are more relaxed, but the arrangement must be commercially genuine. The spouse should be actively involved in the business or have contributed capital to justify the shareholding.
If you are considering alphabet shares, speak to an accountant who understands the director pay and dividends rules. Our ICAEW qualified team at Holloway Davies can advise on structuring shareholdings efficiently.
Corporation Tax Payment Deadlines
Your limited company must pay corporation tax 9 months and 1 day after the end of its accounting period. For a company with a 31 March year-end, the payment is due by 1 January of the following year.
If your company's taxable profits exceed £1.5 million, you must pay in quarterly instalments. That is rare for small companies, but worth knowing if your business grows quickly.
You must also file a corporation tax return (CT600) within 12 months of the year-end. Late filing penalties start at £100 and escalate quickly. For a company that is 6 months late, the penalty is £1,500.
Dividend Tax Reporting
You report dividends on your personal self assessment tax return. The return is due by 31 January following the end of the tax year. For the 2025/26 tax year, the deadline is 31 January 2027.
You do not need to tell HMRC about dividends during the year. You simply report them on your SA100 return. The tax is collected through your self assessment balancing payment or payments on account.
If you do not normally file a self assessment return, you may need to register if your dividend income exceeds the £500 allowance and you have other income that takes you into a taxable position.
Retained Profits and Future Extraction
Many directors choose to leave profits in the company rather than extracting them all as dividends. This is called retained earnings. The company pays corporation tax on those profits, but no dividend tax is due until the profits are distributed.
If you later sell the company, those retained profits increase the value of your shares. When you sell, you may qualify for Business Asset Disposal Relief (BADR). For disposals from 6 April 2025, BADR gives a 14% CGT rate on the first £1 million of gains. From 6 April 2026, that rises to 18%.
This is a long-term planning point. If you plan to sell your company in the next few years, retaining profits rather than taking dividends could reduce your overall tax bill. But the timing matters. Speak to an accountant about your specific situation.
Common Mistakes Directors Make
Here are the most frequent errors we see when advising clients on corporation tax and dividend tax:
- Paying dividends when the company has insufficient retained profits. Dividends must be paid from distributable profits (accumulated realised profits minus accumulated realised losses). If you pay dividends without sufficient retained profits, the dividends are illegal and must be repaid.
- Not accounting for the dividend allowance correctly. The £500 allowance is a zero-rate band, not a deduction. It does not reduce your total income for band calculation purposes.
- Taking dividends before the company has paid its corporation tax. This is fine legally, but it means you are distributing profits that have not yet been taxed. Make sure you have enough cash left to pay the corporation tax bill.
- Ignoring the associated companies rule. If you have two or more companies, the corporation tax thresholds are divided by the number of associated companies. This can push a profitable company into the marginal relief band or even the main rate.
When to Speak to an Accountant
If your company's profits are consistently above £50,000, or if you have multiple shareholders, or if you are considering selling the business, the interaction between corporation tax and dividend tax becomes more complex. A qualified accountant can run the numbers for your specific situation.
At Holloway Davies, we help limited company directors across the UK structure their tax affairs efficiently. Our services include corporation tax planning, dividend strategy, and full self assessment preparation. If you want to understand your optimal salary and dividend mix for 2025/26, get in touch.
The key takeaway is this: corporation tax and dividend tax are two separate taxes on the same underlying profit. Understanding how they interact allows you to plan your drawings efficiently, keep more of your money, and avoid costly mistakes.