As part of wide ranging attack on the self-employed, chancellor Philip Hammond last year announced plans to tinker with the dividend tax rules, cutting the dividend tax-free allowance from £5,000 to £2,000.
Eighty per cent of investors are not expected to pay tax under the dividend regime, but the big losers will be business owners who have hitherto paid themselves dividends as a more tax-efficient alternative to a salary.
Small businesses with a couple of employees and individuals such as freelancers and contractors who run their own limited companies will therefore feel the pinch more than others. Those with non-Isa and pension investments above the £50,000 mark will also be negatively impacted by the smaller allowance.
Dividends above the £2,000 threshold 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.
MAKE USE OF TAX-EFFICIENT WRAPPERS
Below, Money Observer runs through the various ways investors can minimise their dividend tax liability.
Investors with substantial holdings outside Isas and pensions should consider moving them into a wrapper. The transfer, however, will involve selling and buying back shares, which could produce capital gains. The capital gains tax (CGT) allowance is £11,300.
To avoid the risk of a CGT bill, the process known as 'bed and Isa' or 'bed and Sipp' involves selling enough of your investment to realise gains up to the value of the CGT exemption and then buying them back within your Isa or Sipp, or that of your spouse.
However, you need to be aware that there may be transaction charges involved and there will be a period when your money isn't invested.
The Isa allowance for the 2017-2018 tax year stands at £20,000, and will remain the same for the 2018-2019 tax year.
|Portfolio size||Dividend income||Basic rate tax (7.5%)||Higher rate tax (32.5%)||Additional rate tax (38.1%)|
|£50,000 or less||£2,000 or less||£0||£0||£0|
|£125,000||£5,000 or more||£225||£975||£1,143|
|Source:AJ Bell. Based on a 4 per cent dividend yield.|
BEST LINE OF DEFENCE
Laith Khalaf, senior analyst at Hargreaves Lansdown, says: 'Tax shelters are now investors' best line of defence against the encroachment of dividend tax. The higher Isa allowance allows investors to shelter more of their wealth from the taxman, if they make full use of their allowances.
'Those who don't take advantage of the Isa allowance may regret it, even if their portfolio isn't yielding £2,000 right now. It may well yield that amount in future, or indeed this government or the next may come back for another swipe at the dividend allowance.'
So by taking full advantage of tax-efficient wrappers, most investors will not be affected by the new dividend tax rules.
Bear in mind, however, that in the case of self-invested pensions dividends are tax-free within the wrapper - but when you come to draw on your pension pot, withdrawals that exceed the 25 per cent tax-free allowance will be taxed as income.
Patrick Connolly, a financial planner at Chase de Vere, adds: 'Tax rules change regularly, which is why your personal finances need to be reviewed on a regular basis, to ensure they are set up tax efficiently and in the best way to meet your goals.
'For many people taking basic steps like using tax-efficient wrappers and taking advantage of different tax allowances can make a big difference to their overall finances.'
OTHER WAYS TO BEAT THE DIVIDEND TAX
The personal allowance, which stands at £11,500, may also cover dividend income if your other income sources are worth less than that sum. The allowance will rise to £11,850 from the start of the new tax year.
Assets can be passed between spouses without restriction, so make sure you make full use of both partners' personal allowance.
Specialised investment plans such as onshore and offshore bonds can be used to minimise the tax on dividend income. These plans allow investors to defer tax on payouts. But they are complex products and can be expensive, so seek guidance from a financial adviser.
Gifting dividends to children is another tax-efficient option, if you are confident you won't need the gifted money in future. But, again, it would be prudent to seek financial advice.
See if some of your income can be generated as interest rather than dividends in order to benefit from the Personal Savings Allowance, which allows £1,000 to be held in cash before paying tax. Payouts from bond funds, for instance, count as interest.
Explore whether you can reduce the level of natural dividend income by selecting funds with lower yields and more of a growth focus; make up any shortfall by taking capital withdrawals to utilise your capital gains tax allowance.
- This piece was originally written in March 2017, and has subsequently been updated in March 2018 ahead of the dividend tax change coming into force.