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A £5,000 tax-free dividend allowance launched to encourage shareholder investment is to be cut to £2,000 from April 2018, it was announced in the 2016 budget
The dramatic cut to the allowance introduced in spring 2016 by ex-Chancellor George Osborne to compensate for a higher tax rate means investors are likely to look at placing more capital into ISA’s instead after the change next year.
The tax break means shareholders currently get to hold onto the first £5,000 of dividend income they earn each year.
On any dividend income they earn above that sum, basic rate taxpayers hand over:
Before the £5,000 allowance was introduced last spring, a tax credit system meant that the effective rate of dividend tax was 0% for basic-rate taxpayers and 25% for higher-rate taxpayers.
The dividend allowance cut to £2,000 announced in 2016 will cost basic rate taxpayers £225, higher rate taxpayers £975 and additional rate taxpayers £1,143 a year, according to accounting industry estimates.
According to a statement from Chancellor Phillip Hammond, half of the people who currently benefit most from the tax break are company directors with a shareholding in their business, who effectively get to take an extra £5,000 tax-free amount of cash out of their firms each year.
The other half are people who hold £50,000 plus of investments outside their usual ISA allowance, which is currently £15,240 but is set to rise to £20,000 from this April.
In practice the previous dividend allowance of £5,000 allowed investors to hold around £150,000 of equity-based portfolios tax-free.
The announcement of a reduction of this allowance to £2,000 will slash the size of the portfolio that can be held tax efficiently by over 50 per cent.
It’s believed that the economy will expect to see an increase in the use of tax-efficient wrappers such as ISA’s, pensions and investment bonds as investors seek to mitigate their increased tax exposure.
It is widely accepted that the government’s cut to the dividend allowance from £5,000 to £2,000 makes ISA’s more important than ever.
You don’t need a massive portfolio to have a dividend income of over £2,000 only around £50,000.
It has been stated that as part of the proposals around creating equality between different types of working, the £5,000 dividend allowance has been reduced to £2,000 from April 2018.Many people have opted to work through a personal company taking remuneration as a mix of dividends and salary and this change will reduce the attractiveness of taking dividends from a company. According to the Budget statement about half of those affected will be those using personal companies in this way.
On a more general level however, the allowance was introduced to take effect from April 2016 as part of an overall package of measures to reform dividend taxation. The effective tax rate was increased, although this was partially offset by the introduction of the dividend allowance. Those receiving higher levels of dividends paid more tax than they had previously. The reduction in the allowance will ultimately increase this differential.
Under the 2016 changes basic rate taxpayers were affected if their dividend income exceeded £5000:
With the reduction to £2,000 the break-even points become £2,000:
An observation could be the annual dividend allowance had been ‘put to the sword’ by Philip Hammond less than a year after his predecessor George Osborne introduced it, which is a systematic shift in policy by the government.
The cut from £5,000 to £2,000 in April 2018 will make it even more important that investors make full use of the tax allowances available through ISA’s and SIPP’s (Self-Invested Personal Pensions).
So, in particular investors will need to think carefully about which investments they hold inside and outside of tax wrappers. They will want to ensure that high dividend paying investments are held within ISA’s and SIPP’s to minimise the impact of the dividend allowance cut.