Dividend tax-take hits record - October 14th 2024

Nearly 3.6 million taxpayers are expected to be facing a tax charge on dividend income for 2024/25; double the number just three years ago. The allowance is now just £500, but there are various ways of avoiding this dividend tax cost, although not all will be appropriate for every investor.

The dividend allowance has been in HMRC’s sights for the past three years. It was previously set at £2,000, but it was reduced to £1,000 for 2023/24, and to £500 from 2024/25 onwards. This latest reduction has had the biggest impact on basic-rate taxpayers. Just under 700,000 basic-rate taxpayers paid tax on dividend income for 2022/23, but this number will hit nearly 1.7 million for the current tax year.

Tax liability

If you have a modest share portfolio of just over £10,000 yielding 5% it will now use up the £500 dividend allowance, leaving you with a tax liability HMRC needs to know about.

• You can notify HMRC by contacting the helpline, asking HMRC to collect tax via a tax coding change (if employed), or completing a self-assessment tax return.
• With a basic rate of 8.75% on dividend income, the amount of tax due will often be frustratingly low given the inconvenience involved.
• The average amount of tax due from basic rate taxpayers is estimated to be £385 for the current tax year; down from £780 three years ago.

At the same time as the dividend allowance has been cut, the level of dividend payouts by companies has generally recovered to pre-Covid-19 levels.

Opting for script dividends will make the outcome more onerous. These are still taxable despite no cash being received, so tax will have to be funded from other sources. The same goes for accumulation funds where dividends are reinvested automatically.

Mitigation

If dividend income exceeds the £500 allowance, mitigating steps that can be taken might include:

• Using ISAs to shelter up to £20,000 of investment each year. Existing investments can be sold and reinvested, but care needs to be taken with this strategy because gains will be crystallised.
• Using pensions to shelter investments – especially SIPPs. However, there is less flexibility than with an ISA because funds are locked away until age 55 (57 from 6 April 2028). Existing investments can be sold and reinvested.
• Spreading a share portfolio across the family can make use of unused dividend and ISA allowances. It will also be worthwhile if dividend income will be taxed at a lower rate. This planning will work whether a spouse, partner or adult child is involved, but gains are crystallised if existing investments are gifted to anyone other than a spouse or civil partner.
• Using venture capital trusts to produce tax-free dividends, although the high level of risk involved here means such an investment will not be suitable for most investors.
• Investing for capital growth rather than dividend income. Although this approach will minimise tax on dividend income, it can result in the equally intractable problem of a much higher CGT liability. At least there is control over when gains are realised.

Investors need to be careful, however, that decisions are not made just to save tax. Never lose sight of the importance of overall investment return and maintaining a balanced portfolio.

Please contact us to discuss.