The headlines after last week’s Budget were grabbed by the National Insurance (NI) rise. Although this has now been cancelled, it would have seen the bills of many self-employed people increase from next year.
But, the furore caused by the proposed hike, has meant another tax increase, also announced in the Budget, has been largely ignored. And millions of people will be affected.
Tax on dividends
The way dividends are taxed changed last April. A new annual tax-free allowance of £5,000 was introduced, with any dividends received above that amount taxed as follows:
- Basic rate taxpayers: 7.5%
- Higher rate taxpayers: 32.5%
- Additional rate taxpayers: 38.1%
Who did the changes affect?
The changes affected two key groups of people:
- Business owners trading under a limited company structure and taking income in the form of dividends. Don’t be fooled into thinking this will just affect ‘fat cats’ and senior executives. Anyone, from freelancers and contractors, to the head of FTSE 100 companies, will be affected
- Investors who receive dividends on investments not held in a tax-efficient ‘wrapper,’ such as a pension or Individual Savings Account (ISA). Again, these people are not necessarily affluent, they could simply be savers, forced to consider investing, due to low interest rates
For many people, the tax savings generated by the £5,000 allowance were wiped out by the additional tax paid on dividends. In fact, the changes saw tax bills rise for business owners and investors.
It should also be remembered that the money paid out in dividends has in fact already been taxed, with Corporation Tax paid by the company on profits made. Until the changes in April 2016, this meant basic rate taxpayers paid no additional tax on dividends.
What’s changing now?
Less than a year after the new rules were introduced, Philip Hammond announced in last week’s Budget that the £5,000 tax-free allowance will be cut in April 2018 to just £2,000.
This news has been largely overlooked by the media. Despite the fact it will affect many small businesses, exactly the same type of people who would have been hit by the National Insurance increase.
The change will raise nearly £1 billion for the Treasury, far more than the proposed NI changes and, according to Government figures, will cost those affected an average of £315 per year.
How can you avoid paying more tax?
Business owners: Bluntly, if you need the income you’ll have to pay the tax.
Of course, you could also consider other ways of taking money tax-efficiently from your business. For example, payments into pensions, which qualify for corporation tax relief.
Investors: Research shows that typically investors with portfolios of £50,000 – £75,000, or more, will be affected. The answer may be to shelter as many dividend paying assets as possible in tax-efficient vehicles; principally ISAs and Pensions.
From April investors can pay up to £20,000 into ISAs. You can also pay the lower of your earnings or £40,000 into a pension.
Using an ISA to shelter investments from tax is a no brainier. But, paying money into a pension, although attractive due to the tax-relief you will receive, needs more consideration. The capital is locked away until you are 55 and when you withdraw money it may be taxed.
If you decide to move money into an ISA or pension, it’s important that the investments you move are those generating the highest dividend, with those paying less, held outside.
Investors considering moving money into an ISA or Pension must also consider any Capital Gains Tax (CGT) implications. If a profit has been made on the investments, in excess of the annual CGT allowance, then tax could be due.
Finally, you have a spouse or civil partner who does not receive dividends, or is in a lower tax band, you could also transfer assets to their name and take advantage of the tax-free dividend allowance or a lower tax rate. Importantly, this movement of assets would not attract a Capital Gains Tax bill, as transfers between spouses are exempt.
Complicated, isn’t it?
It’s clear the cut to the tax-free dividend allowance will push up the tax bill of millions of people.
If you are one of those people, you have two choices: pay the tax, or take measures to avoid it.
If you are in the second camp, advice is crucial to help you make the right decisions. We are here to help, if you would like to discuss how these changes will affect you, please get in touch by calling us on 0207 808 4120.