Budget 2017: dividend tax allowance to be cut to £2,000
Chancellor Philip Hammond has announced plans to make the tax-free dividend allowance less generous.
Under current rules, which were only introduced last April, there is no tax to pay on the first £5,000 of dividend income in each tax year. Dividends above that threshold will be taxed at 7.5% for basic-rate taxpayers, 32.5% for higher-rate taxpayers and 38.1% for additional-rate taxpayers.
But from April 2018 the allowance will be reduced from £5,000 to £2,000. The move will result in more investors being caught by the reformed dividend tax regime.
Currently, based on a yield of 3%, it requires a portfolio of £166,667 to generate £5,000 of dividend income. With a 4% yield, this figure drops to £125,000, and with a 5% yield it falls to £100,000.
Tax advantage of tax-efficient wrappers
From April 2018 on a 3% yield, the £2,000 of dividend income will be generated by a portfolio of £66,668. For a 4% yield the portfolio size will fall to £50,000 and for a 5% yield the portfolio size will fall to £40,000.
But it is worth remembering that all dividends generated within Isas remain free of tax and the Isa allowance is set to become even more generous in the 2017-2018 tax year, rising from £15,240 to £20,000.
So by taking full advantage of tax-efficient wrappers, most investors will not be affected by the new dividend tax rules.
Those with sizeable investments outside of an Isa, typically £50,000 or more, are likely to be caught by the allowance change, as are shareholder directors.
"It will ensure that support for investors is more effectively targeted, and make the total amount of income they can receive tax-free fairer and more affordable.
"This takes account of the increased Isa allowance, which will rise to £20,000 from this April, as well as further increases to the tax-free personal allowance which is additional to the dividend allowance," said the government.
Les Cameron, head of technical at Prudential, said the dividend allowance cut £2,000 will reduce the size of the portfolio that can be held tax efficiently by over 50%.
"As a result we expect to see an increase in the use of tax-efficient wrappers such as Isas, pensions and investment bonds as investors seek to mitigate their increased tax exposure," adds Cameron.
While 80% of investors are not expected to pay tax under the dividend regime, the biggest losers will be business owners who have hitherto paid themselves dividends as a more tax-efficient alternative to a salary.
Therefore, small businesses with a couple of employees, and individuals such as freelancers and contractors who run their own limited companies, will feel the pinch more than others.
This story was originally written for our sister magazine, Money Observer.
The general term for the rate of income from an investment expressed as an annual percentage and based on its current market value. For example, if a corporate bond or gilt originally sold at £100 par value with a coupon of 10% is bought for £100 then the coupon and the yield are the same at 10%, or £10. But if an investor buys the bond for £125, its coupon is still 10% (or £10) and the investor receives £10 but as the investor bought the bond for £125 (not £100) the yield on the investment is 8%.
Invidivual Savings Accounts were introduced on 6 April 1999 to replace personal equity plans (PEPs) and tax-exempt special savings accounts (TESSAs) with one plan that covered both stockmarket and savings products, the returns from which are tax-exempt. The ISA is not in itself an investment product. Rather, it’s a tax-free “wrapper” in which you place investments and savings up to a specified annual allowance where the returns (capital growth, dividends, interest) are tax-exempt (you don’t have to declare ISAs and their contents on your tax return). However, any dividends are taxed within the investment, and that can’t be reclaimed.
If you own shares in a company, you’re entitled to a slice of the profits and these are paid as dividends on top of any capital growth in the shares’ value. The amount of the dividend is down to the board of directors (who can decide not to pay a dividend and reinvest any profits in the company) and they will be paid twice yearly (announced at the AGM and six months later as an interim). Dividends are always declared as a sum of money rather than a percentage of the share’s price. Although dividends automatically receive a 10% tax credit from HM Revenue & Customs (HMRC), which takes the company having already paid corporation tax on its profits into account. Dividends are classed as income and, as such, are liable for personal taxation and so shareholders have to declare them to HMRC.
There are limits to how much you can invest in any tax year. For 2011/12, the limit is £10,680. Of that, the maximum you can invest in cash is £5,340 and the balance of £5,340 can be invested in shares (individual company shares or investment funds). If you don’t take the cash ISA allowance, you can invest up to £10,680 into a stocks and shares ISA.