UK Contractor Tax Changes: 2025/26 vs 2026/27

Income tax and National Insurance: side by side

The core income tax and NI rates are identical in both years. The freeze continues.

Source: HMRC published rates

The 2% dividend tax hike: what it really means

The headline change for the 2026/27 tax year is a 2 percentage point increase in dividend tax rates at both the basic and higher rate bands. This was announced in the Autumn Budget 2024 alongside the employer NI changes, but takes effect a year later — from 6 April 2026.

For context, dividend tax rates have risen sharply over the past five years. In 2021/22, the basic rate was 7.5% with a £2,000 tax-free allowance. By 2023/24, the allowance had been slashed to £1,000, then to £500 from April 2024. Now the rate itself is climbing: 8.75% in 2022/23, and 10.75% from April 2026. For higher-rate taxpayers, the trajectory is similarly steep — from 32.5% in 2021/22 to 35.75% in 2026/27.

The additional rate (for dividend income above £125,140) stays at 39.35%. The £500 tax-free dividend allowance also remains unchanged.

National Insurance: the dust settles

The 2026/27 tax year brings no new National Insurance changes. Both employer and employee NI rates are identical to 2025/26. But that does not mean the pain has passed — the seismic shift that took effect in April 2025 continues to ripple through contractor finances.

What happened in April 2025

The Autumn Budget 2024 delivered a double blow to employer National Insurance. The rate rose from 13.8% to 15%, and the secondary threshold — the point at which employer NI starts being charged — was slashed from £9,100 to £5,000. Together, these changes increased the cost of employing someone by hundreds of pounds per year.

For limited company directors, the impact is felt through higher employer NI on their salary. A director taking the standard £12,570 salary now pays £1,136 in employer NI, compared to £479 under the old threshold — an increase of £657 per year. That cost comes directly out of the company's distributable profits, meaning less available for dividends.

The umbrella contractor squeeze

Umbrella contractors are hit hardest by the employer NI changes. Unlike limited company directors, umbrella workers see employer NI deducted from their assignment rate — not added on top. This means the higher employer NI directly reduces their take-home pay. A contractor on £500/day through an umbrella company takes home significantly less than the same rate through a limited company, and that gap widened in April 2025.

Capital gains tax and Business Asset Disposal Relief

Contractors planning to sell or wind down their limited company need to pay close attention to the accelerating rise in Business Asset Disposal Relief (BADR) rates. Formerly known as Entrepreneurs' Relief, BADR provides a reduced capital gains tax rate on the first £1 million of lifetime gains when disposing of qualifying business assets.

The Autumn Budget 2024 set out a two-year transition to align BADR with the main CGT lower rate. In 2024/25, BADR was charged at 10%. From April 2025, it rose to 14%. From April 2026, it climbs again to 18% — now matching the standard CGT basic rate. For higher-rate taxpayers, the standard CGT rate stands at 24% (set in October 2024).

The practical impact: a contractor selling their company with £200,000 in qualifying gains would pay £36,000 in CGT under BADR in 2026/27, compared to £28,000 in 2025/26 and £20,000 in 2024/25. That is an £8,000 increase in a single year.

BADR applies to the first £1m of lifetime qualifying gains. Source: GOV.UK. CGT rates from GOV.UK.

If you are considering closing your company or extracting retained profits, the trend is clear: earlier is cheaper. The annual allowance for capital gains was also cut to £3,000 in 2024/25 (from £6,000 the year before), further reducing the tax-free amount. Speak to your accountant about timing — particularly if you have significant retained profits.

Frozen thresholds: the silent tax rise

Since 2021/22, the personal allowance has been frozen at £12,570 and the higher rate threshold at £50,270. This freeze was originally set to last until 2025/26 but has been extended to at least 2028/29. In 2026/27, these thresholds remain unchanged for the sixth consecutive year.

The effect is subtle but cumulative. As wages and prices rise with inflation, more income is pushed into higher tax bands even though tax rates themselves have not changed. This is known as fiscal drag, and the Office for Budget Responsibility has estimated it will bring 4 million additional taxpayers into the higher rate band by 2028 compared to if thresholds had risen with inflation.

For contractors, the impact depends on how you structure your income. Limited company directors who keep their salary at the personal allowance (£12,570) and take the rest as dividends are partially shielded — dividend income has its own bands and is not subject to NI. But sole traders and umbrella contractors, whose entire income flows through PAYE, feel the full force of fiscal drag.

The £100,000 trap

One of the most punishing features of the frozen threshold regime is the personal allowance taper. For every £2 earned above £100,000, the personal allowance reduces by £1 — creating an effective marginal tax rate of 60% (or 62% including NI) on income between £100,000 and £125,140. This trap has existed for years, but as more contractors are pushed towards and past £100,000 by inflation, more people are being caught by it.

If your gross income is near the £100,000 mark, pension contributions are one of the most effective ways to reduce your taxable income below the taper threshold. Each £1 contributed to a pension in this band effectively saves 60p in tax.

Looking ahead: what's on the horizon

While the 2026/27 tax year is now largely settled, several upcoming changes are worth noting for medium-term planning:

• Making Tax Digital for Income Tax (April 2026): Sole traders and landlords with income above £50,000 must begin filing quarterly digital updates to HMRC from April 2026. The threshold drops to £30,000 from April 2027. This does not affect limited company directors directly, but sole trader contractors need to ensure their accounting software is MTD-compatible.
• ISA reform (April 2027): The government has signalled simplification of the ISA system. While details are pending, changes could affect how contractors shelter investment income. The annual ISA allowance (£20,000) has been frozen since 2017.
• Electric vehicle mileage rates: Advisory fuel rates for fully electric company cars are expected to be reviewed in 2028. Contractors who claim mileage through their limited company should watch for updates, as the current 5p/mile advisory rate for EVs has been widely criticised as too low.
• Umbrella company regulation: New PAYE compliance rules for umbrella companies took effect in April 2026, giving HMRC greater powers to pursue non-compliant operators. Contractors using umbrella companies should ensure their provider is compliant and transparent about deductions.

The Autumn Budget 2025 will set the agenda for 2027/28. With the threshold freeze expected to continue and BADR now aligned with the main CGT rate, the direction of travel for contractor taxation is clear: higher effective rates through a combination of rate increases and frozen allowances.