The new dividend tax regime, introduced at the start of the 2016 tax year, will primarily hit owners of small businesses who pay themselves dividends rather than take an income. However, the tax changes will also affect some investors.
We reveal the winners and losers, and below offer some tips on how to reduce the amount of dividend tax you pay to a minimum. First, we look at how the new tax rules work in practice.
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 per cent for basic-rate taxpayers, 32.5 per cent for higher-rate taxpayers and 38.1 per cent for additional-rate taxpayers.
Under the old rules, dividends were received by investors net of a notional 10 per cent tax credit. This, however, could not be reclaimed. Basic-rate taxpayers paid no tax on dividends. Higher- and additional-rate taxpayers paid 25 and 30.56 per cent tax respectively.
There are more winners than losers under the new rules, according to analysis by the government: it says 75 per cent of dividend recipients will be better off.
Higher-rate and additional-rate taxpayers who receive less than £5,000 of dividend income are the big winners, as they will now pay no tax.
For higher-rate taxpayers with less than £5,000 of dividend income, this represents a saving of up to £1,250. Additional-rate taxpayers will do even better, to the tune of £1,528.
Those who receive dividend income above this figure will also pay less tax, up to a point.
Research by adviser Chase de Vere found that the break-even point for a higher-rate taxpayer will come when their dividend income reaches £21,667. For additional rate taxpayers the figure is £25,250.
Patrick Connolly, a financial planner at Chase de Vere, says: 'Once dividend income breaches these levels, an investor will be paying more tax than under the previous system.'
Not everyone is a winner. After all, the new tax will raise nearly £9 billion for the Exchequer by 2021. Basic-rate taxpayers who receive more than £5,000 in dividend income are obvious losers. Previously, they paid no tax, no matter how much they received in dividends.
The biggest 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 feel the pinch more than others.
When the new dividend tax was announced, the Treasury said: 'While these rates remain below the main rates of income tax, those who receive significant dividend income - for example, due to large shareholdings (typically of more than £140,000) or as a result of receiving significant dividends through a closed company - will pay more.'
Connolly says: 'Business owners will generally be worse off under the new legislation. But in most cases, paying dividend tax will remain more tax efficient than paying themselves a salary.'
HOW TO MINIMISE YOUR DIVIDEND TAX LIABILITY
Most dividend recipients will not pay any dividend tax. Based on a yield of 3 per cent, it requires a portfolio of £166,667 to generate £5,000 of dividend income. With a 4 per cent yield, this figure drops to £125,000, and with a 5 per cent yield it falls to £100,000.
Moreover, all dividends generated within Isas remain free of tax; up to £15,240 can be invested in an Isa this tax year. The personal allowance of £11,000 may also cover dividend income if your other income sources are worth less than that sum.
Self-invested personal pensions are also beneficial here, in that dividends are tax-free within the wrapper. But bear in mind that any withdrawals will be taxed as income.
So by taking full advantage of tax-efficient wrappers, most investors will not be affected by the new dividend tax rules.
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 trigger a capital gains tax (CGT) bill. The CGT allowance is £11,100.
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, as a CGT bill might be triggered.
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