Synopsis: An initial look at the impact on individual investors of the reform of dividends announced in the Summer Budget.

In his Budget speech, the Chancellor said ‘85% of those who receive dividends will see no change or be better off. Over a million people will see their tax cut.’ Are the changes really that good?

From the viewpoint of an investor whose marginal rate of tax is above basic, the £5,000 dividend allowance is very generous:

· For a higher rate taxpayer, the allowance represents a saving of up to £1,250 (£5,000 @ [22.5%/0.9]). To end up with a bigger overall tax bill on their dividends, the 40% taxpayer would need to receive total net dividends (i.e. not grossed up) of over £21,667.

· For an additional rate taxpayer, the corresponding figures are £1,528 and £25,250.

The investor’s worst affected – although there will be few – are basic rate taxpayers with dividend income above £5,000. At present they pay no tax until they hit the higher rate threshold whereas from 2016/17 they will pay 7.5% tax. In other words, the dividend tax change is regressive, at least as far as most investors are concerned.

In his speech Mr Osborne also said ‘Those who … have large shareholdings worth typically over £140,000 will pay more tax’. That figure was a crude stab based on the fact that the FTSE All-Share Index yields about 3.5% (£140,000 @ 3.5% = £4,900). In practice, for most investors the value threshold will be higher because:

(i) most collective investments will have charges deducted from income before dividends are paid, so the actual yield will be lower than the market figure; and

(ii) The UK is a relatively high yielding market. The S&P 500 yields just under 2% and the MSCI World Index (admittedly 57.6% USA) yields about 2.5% (implying a portfolio threshold of £200,000).

So what are the consequences of these changes? At present there are some imponderables as the Treasury/HMRC has provided only limited information. With that in mind, the following list must be regarded as somewhat provisional in nature:

· An end to grossing up makes dividends the most attractive form of income for those worried by thresholds based on total gross income (e.g. personal allowance phasing out, child benefit tax and next year’s annual allowance cutback). £100 of dividend is £100 of gross income, too and is worth the same as £125 of gross interest/earnings (ignoring NICs) to a basic rate taxpayer. For higher and additional rate taxpayers with dividend allowance to spare, the corresponding figures are £166.67 and £181.82. Once the £5,000 allowance is breached then the equivalent gross interest/earnings amount drops to about £112.50.

· Just as next year’s personal savings allowance has raised issues about the value of cash ISAs, so the dividend allowance poses a similar question for stocks and shares ISAs. Until the dividend allowance is exhausted, the main advantage is CGT, which few investors pay anyway.

· The higher rates of tax on dividends above the dividend allowance make collectives where charges are deducted from income more attractive than externally managed portfolios, where the investor meets costs from the income they receive. This has always been the case for higher and additional rate taxpayers, but it becomes more so with the higher rates and will now also catch basic rate taxpayers. The result may be more managed portfolios within a single collective wrapper.

· UK investment bonds may have become more attractive. Once the dividend allowance is exceeded, tax rates of 7.5%, 32.5% and 38.1% will apply to the net dividend. By contrast the tax rate applicable via an onshore bond on gains will be 0%, 20% and 25%. Usually this would be countered by the more favourable capital gains treatment on a personal basis, but the chances are that once the dividend allowance is exceeded, there may be little or no annual exemption available. At that point overall tax on capital gains via a bond do not look too bad, particularly once the internal indexation relief is taken into account.

HOWEVER – and it is a big however – we do not know whether there will be any revision to the rate of tax levied dividends received in policyholders’ funds. s102 (2) Finance Act 2012 sets the policyholders’ rate of tax on income as ‘the rate at which basic rate tax is charged’. Will that become 7.5% for dividends from 2016/17 or remain at an effective 0%? If it is 7.5%, then there will be a much smaller marginal advantage for higher and additional rate taxpayers.

· The dividend allowance (along with the personal savings allowance) could mean fewer self-assessment returns issued, because there will be no extra tax to collect if earnings/pension are covered by PAYE. This fits in with the Chancellor’s pledge – greeted with much scepticism – to do away with tax returns. A corollary is that for 2016/17 some investors will need to claim a reduction in their payments on account (using from SA303) because they will no longer have as much – if any – extra tax to pay on their dividend income.


This gives a flavour of how the investor’s world will change, but doubtless more will emerge in the weeks ahead as further thought is given to the consequences of the Chancellor’s actions.

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