Dividends? All change...

So, in this month's emergency budget the Chancellor announced the biggest shake up of tax on investment in over a generation. No longer will dividend income for basic rate taxpayers be, in effect, tax free. The 10% notional tax credit that almost all of us have always accepted as a slightly odd anomaly of the tax code is no more, well from next April at least! So, what exactly  does this all mean and how does it affect you, me and all the millions of business owners and investors in the UK?

Well, first of all we have a new £5,000 dividend allowance, which in effect means the first £5,000 of dividend income you receive (be that from your business, or your portfolio) will still be tax free. However, anything over and above that will be subject to 7.5% tax at the basic rate, 32.5% at the higher rate and 37.5% for additional rate taxpayers. As with most changes to the system of taxes in the UK there are various winners and losers as a result.

The is also in addition to the £1,000 savings, or interest allowance that was announced last year. All of which points to government wanting to encourage the small investor in a move away from cash to bolster the financial markets. Well, that is my opinion at least, given that what we are seeing is in effect a tax break for investing in the equities market.


It is possible that investors who have built up sizeable portfolios could be subject to the higher rate. For example, a share portfolio of £125,000 with a yield of 4 per cent will generate £5,000 income a year and use up the dividend allowance. So, we are not talking about something that will affect only the "super-rich" here.

Similarly, for owners of small businesses who have for many a year sought to save tax my taking their remuneration out of their companies as dividend we will see a huge change. Whilst large companies will still be more tax efficient under the new system (although not as efficient as they once were), smaller family businesses may find themselves facing larger tax bills as a corporate entity and the prospect of dis-incorporation looms as a partnership may once again mean paying tax.


So, enough of the doom and gloom, what are the advantages and what can you do to iron out some of the knottier problems:

Maximise your annual tax-free dividend allowance
Each person will be entitled to a new tax-free Dividend Allowance of £5,000 per annum. Married couples (and registered civil partners) should spread their taxable portfolios between them to make full use of each person's allowance.

Make the most of each spouse's income tax allowance and tax bands
It sounds obvious, but married couples should still seek to make full use of their personal allowances and basic rate tax bands, where applicable, so that taxable dividends are paid in the name of the spouse who pays the lowest tax rates.

Defer taxation using an investment bond
Dividend income within an investment bond grows almost free of taxation. Investors only pay tax when profits are withdrawn from the bond, and even then withdrawals of up to 5 per cent of the original capital per year (cumulative) can be taken without an immediate tax charge.

Don't forget your ISA
Taxpayers will see a tax increase of 7.5 per cent on dividend income received above £5,000 a year. This makes sheltering taxable investments in an ISA all the more important as unlimited dividends can be withdrawn from an ISA tax-free.  There is also no capital gains tax to pay in an ISA. Up to £15,240 worth of existing investments can be sheltered in the current tax year.

So what about business owners?
Well, at present the picture is far from rosy, and although the "tax scheme industry" has already rolled up its sleeves to come up with a cunning plan I fear it will end as most of Baldrick's did in disaster for the participants. That said, this is not all bad news, the current system of taxation on dividends has always seemed a bit odd when compared to the rest of the tax code, and for the vast majority will still be preferential to taking a salary. Unfortunately, it really is only those on the fringes of this argument who will see a genuine negative effect and as I've already said dis-incorporation might be attractive, there is after all a £100,000 relief available after all!