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New tax on share dividends

By Richard Evans

7:12AM BST 14 Jul 2015

George Osborne’s new tax on share dividends, announced in last week’s Budget, has been the cause of both dismay and confusion.


Readers have written to say they expect their retirement incomes to be severely affected by the new tax, while others are baffled about how it will work – particularly whether abolition of the old “dividend tax credit” will affect their Isas and pensions.


Here we answer their questions – and offer some tips about how to pay as little dividend tax as possible.

How will the new tax work?

The first £5,000 of dividend income in each tax year will be tax-free. Sums above that will be taxed at 7.5 per cent for basic-rate taxpayers, 32.5 per cent for higher-rate taxpayers and 38.1 per cent for additional-rate taxpayers. The new tax takes effect on April 6, 2016. No tax will be deducted at source; taxpayers must use self-assessment to pay any tax due.

How does this differ from before?

Under the current system, basic-rate taxpayers pay no tax on their dividend income, while higher-rate taxpayers pay an effective rate of 25 per cent and additional-rate taxpayers pay 30.56 per cent. So taxpayers in all bands pay less than they would on earned income. This is because dividends are paid out of company profits that have already suffered corporation tax.

Will everyone be worse off under the new regime?

No. While it’s true that many will pay more, such as basic-rate taxpayers who receive more than £5,000 in dividends, there are others, such as higher-rate taxpayers with £5,000 or less in dividend income, who will gain – currently they pay 25 per cent on the whole sum (or £1,250), while under the new regime there will be no tax to pay, thanks to the £5,000 allowance.

What if some of my dividend income is within the tax-free personal allowance?

Dividend income is still eligible for the personal allowance. So if next year you had £16,000 in dividend income, the first £11,000 would be covered by the personal allowance and the other £5,000 by the new dividend allowance. As a result, you would pay no tax.

Will this affect my Isas?

Some investors think they will receive more dividend income within their Isas under the new rules – but they won’t. This is because they expect the abolition of the old dividend tax credit to mean that, after next year, dividends will be paid “gross”.

But this “credit” was entirely notional and could not be reclaimed in hard cash even within tax-efficient vehicles such as Isas.

Instead, the following is what happened. A company declared a dividend of (say) 90p from its (already taxed) profits. This was “grossed up” to 100p – using a “notional” process under which no money changed hands. When the dividend was handed over to shareholders it was “netted” back to 90p, along with a “tax credit” that meant a basic-rate taxpayer had no further tax liability.

Both the notional grossing up and netting down will be abolished and shareholders both within and outside Isas will continue to receive 90p under the new system. Inside Isas nothing will change; outside them the new tax outlined above will apply.

Or my pensions?

Pensions plans, whether occupational or personal, were also unable to reclaim the “tax credit” so nothing will change to the dividends they get. Any dividends received won’t be taxed while they remain in the pension but will be taxable as pension income in line with existing rules when withdrawn by the pension saver. No £5,000 allowance will apply because the recipient of the dividend is the pension scheme, not the beneficiary.

What can I do to minimise the effects of the new tax?

The most obvious idea is to transfer shareholdings into Isas. However, a portfolio that produces £5,000 in dividends is likely to be worth roughly £130,000. Even if you hold very high-yielding shares you would need about £63,000 to generate £5,000 a year, according to calculations by Claire Walsh, a financial adviser at Aspect 8.

With the annual Isa allowance at about £15,000, it would take at least four years to transfer all your shares to Isas. Married couples could use both allowances, however.

You can’t simply move shares to an Isa: you have to sell them, deposit the proceeds in an Isa and then buy them back within the tax-free scheme. One trick is to do this when markets fall, as you can sell more shares and still stay within the Isa limit.

Even if your dividend income is less than £5,000 now, you may want to start switching to Isas because the payments could rise in future, Ms Walsh said.

Specialised investment plans called onshore and offshore bonds, which allow you to defer tax on income, are another option, especially for those who pay the higher rates of tax, she added.

Abraham Okusanya of Finalytiq, a financial planning consultancy, said business owners might want to draw as much as possible in dividends before the new rules took effect in April next year.

Case study: 'This is a £2,000 hit to our pension income'

Owen Evans expects his retirement income to fall by about £2,000 a year as a result of the new tax.

Mr Evans, 71, who lives near Swansea with his wife, Veronica, 68, invested several hundred thousand pounds in high-yielding shares when he retired as a businessman six years ago.

“It was the first time that I had a substantial capital sum to invest, as, during most of my self-employed career, profits had to be reinvested for business reasons, and I did not have a large pension fund,” he said.

“The new tax seriously affects people like myself, and the £5,000 allowance is derisory. The allowance should be at least £20,000.”

Transferring a large portfolio such as his into Isas would take a great many years. “The Chancellor has forgotten retired people,” he said. “I hope MPs will attempt to amend the law to give them a better deal as the law goes through Parliament.”




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