Dividend tax credits will be replaced with a new £5,000 tax-free allowance from April 2016, the Chancellor George Osborne announced during his Summer Budget statement.
Under current rules dividend income is reduced with tax credits. Basic rate taxpayers currently pay no tax on dividend income while higher rate taxpayers are charged 25% and additional rate taxpayers 30.55%.
From April 2016, investors will pay no tax on dividend income below £5,000 but income exceeding the allowance will be taxed at the following rates:
• Basic rate taxpayers: 7.5%
• Higher rate taxpayers: 32.5%
• Additional rate taxpayers: 38.1%.
The dividend allowance will be in addition to the £1,000 personal savings allowance for income such as bank interest.
Nigel Holland from Holland & co Chartered Accountants said:
“ This new move by the Government could have a significant impact on business people who depend upon their dividends because if they receive in excess of £5,000 per year in dividends then they will be worse of financially.
There needs to be very careful tax planning by shareholders who are in receipt of dividends for them to decide what is the best way forward. Higher rate tax payers will be hit even more because they will be charged 32.5% and if any one is lucky enough to be an additional rate taxpayer the 38.1% charge will be a significant amount for them to pay.
At my firm we are currently examining ways round this problem. Investors will need to navigate their way around the new rules carefully to avoid tax rises.
It is important that apathy does not set in because this could be very costly for an investor. People should fully use their tax shelters such as an ISA, even if they think their income or gains will currently fall within tax-free allowances.
People never know when things might change in the future so it’s best to bank your tax breaks while you still can.
How to beat dividend tax rises:
• Use your ISA allowance now
Unlimited dividends can be withdrawn from an ISA tax-free, which is why sheltering taxable investments in the accounts will become all the more important.
• Maximise your annual tax-free dividend allowance
Married couples and registered civil partners should spread their taxable portfolios between them to make full use of each person’s allowance.
It is important that couples should also make full use of personal allowances and basic rate tax bands, where applicable, so that taxable dividends are paid in the name of the spouse who pays the lowest tax rates.
• Consider a SIPP
SIPPs (Self-Invested Personal Pensions) also have the benefit of tax-free dividends.
For retirement savings where money is not needed until age 55 the tax benefits of SIPPs make it a good option for many.
• Be clever with yield
Some shares do not pay out any dividend or maybe pay out a smaller level of dividend. Instead of dividends being paid, the value of the shares may increase. A diverse portfolio will have shares and funds that generate different levels of dividend income yield.
It may be worth sheltering those that generate the highest yields in an ISA to maximise the dividend income tax allowance.
• Reduce other income
Dividend tax is linked to the rate of income tax you pay, so look to move down a tax band where possible.
For instance, in some cases taxable income for a particular year could be reduced.
Think about transferring income bearing assets such as cash deposits to a lower earning spouse, or deferring withdrawals from a drawdown pension until a new tax year.
• Invest in VCTs
For taxpaying, sophisticated investors, happy to take higher risks, Venture Capital Trusts (VCTs) generate tax-free dividends.
These tax-free dividends will be payable in addition to tax-free dividends from an ISA and tax-free dividends within the new £5,000 Dividend Allowance.
It is clear that anyone who holds stocks and shares needs to review their investments and ensure they do not pay any more tax than necessary.
Some people who are in receipt of dividends may now need to complete self assessments when previously this may not have been necessary. They may be obliged to disclose these dividends on their self assessments”