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
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
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,
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
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
“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.”