The Daily Telegraph - Saturday - Money
‘I’ll pay tax on dividends for the first time ever’
One of many angry investors explains how her £16,000 income will be hit by the Government’s tax change. By Laura Suter
Ageneration of mainly elderly investors are discovering that their reliance on investments to provide modest dividend income is about to result in a crippling tax blow. For some, such as reader Susan Scott, aged 77 (see right), it will be the first time she has ever had to pay tax on this type of income.
The fact that this tax was introduced by a Conservative government is an added irony.
In last month’s Budget, Chancellor Philip Hammond announced that the recently launched “dividend allowance” is being cut from £5,000 per year to £2,000. The change, effective from next April, means that the amount of money that can be earned from dividends tax-free has been slashed by more than 60pc.
But that is not all. A succession of changes to dividend taxation means people like Mrs Scott are effectively hit with a “double whammy”.
Before the introduction of the £5,000 dividend allowance in 2016 a notional tax credit of 10pc was applied to dividend income paid by UK and some non-UK companies. This effectively meant that basic-rate taxpayers paid no tax on dividend income, while higher rate taxpayers paid 25pc.
On April 6 2016, this 10pc credit was abolished, alongside the introduction of the dividend allowance. At the same time the tax rates were raised to 7.5pc for basic rate taxpayers, 32.5pc for higher rate taxpayers and 38.1pc for additional rate. Combined, these two measures mean that many taxpayers will now be hit twice, leading to a tax bill on their dividends for the first time.
In effect, until April 2016 you could earn up to £42,385 a year in dividends (£10,600 from the personal tax-free allowance and another £31,785 to take you up to the limit for basic-rate tax threshold) and have no tax to pay.
This effectively dropped to £16,000 from April 2016 – £11,000 from the personal allowance and the £5,000 dividend allowance.
From April 2018 this will be slashed again, to £13,500 (£11,500 in personal allowance plus the new £2,000 dividend allowance). This is an effective cut of 68pc in the allowance over just two years.
The Government said that the latest dividend allowance cut will affect 2.3 million people in 2018-19, resulting in an average loss of around £315. But many will pay far more.
‘I have owned shares since the Seventies, but this will be the first time I’ve paid tax’
Mrs Scott is one investor who will be caught out by the changes in Government rules. She relies on investment income to fund her retirement.
Mrs Scott was a stay-at-home mother and housewife for much of her life. Because of this she only receives £3,764 a year in the married woman’s state pension. But through inheritances and shrewd investing she has built up a £500,000 share portfolio, paying her just over £16,000 in dividend income each year. She also has around £3,500 in interest from savings account and fixed-term bonds.
“My first inheritance was from my grandmother, who believed all married women should have their own income and not be entirely dependent on their husband so, when she died in 1974, she left me £20,000,” said Mrs Scott. She then had further inheritance from her parents, and now has around £250,000 held directly in dividend paying stocks, such as GlaxoSmithKline and National Grid, and the same amount in income-
focused investment trusts such as HICL, Murray International and RIT Capital Partners.
“I reckon I will have to pay £1,000 in income tax from next tax year,” she told Your Money. “I’ve never paid tax, I’ve always had tax rebates. I shall have to be quite careful to keep that money in the bank,” she said.
Mrs Scott’s holdings are mainly outside of an Isa, because previously “there was no need to protect these investments from income tax”.
“I’ve only recently started putting some of the investments in an Isa as, before, it didn’t really pay me to do so,” she said.
Mrs Scott added that the various allowances make it very confusing for individuals filing their selfassessment tax return.
Mrs Scott hopes that she can use the personal allowance of £11,500, the personal savings allowance of £1,000, and the dividend allowance of £5,000, (or £2,000 from next year) to reduce her tax bill – but has no idea how they work together.
Christopher Springett, partner at Smith & Williamson, the tax specialist, said: “Mrs Scott was always on the losing side of the equation following the change in the regime for taxing dividend income with the £5,000 allowance not compensating for the increase in tax rates and loss of the tax credit.
“The proposed reduction of the dividend allowance to £2,000 exacerbates this, increasing the tax Mrs Scott now needs to pay on an annual basis. This does seem harsh, especially as Mrs Scott is not necessarily the target of the reduced dividend allowance.”
How the various allowances apply
Investors wanting to make the best use of their various tax allowances can decide in which order they are applied, said Mr Springett.
HMRC has admitted that its self-assessment tax calculation does not always give the most tax-efficient outcome, he said, which means that individuals cannot rely on the taxman to use the tax breaks to the best effect.
In Mrs Scott’s case if she relied on HMRC, her pension income, then savings income and then dividend income would be taxed in that order. This means that she would waste her £1,000 personal savings allowance. This is because her savings income of £3,500 would be set against her general personal allowance.
Danby Bloch, director of Taxbriefs, said: “The order in which income is taxed means that the personal allowance is first set against her pension income of £3,760 and then against her savings income from interest of £3,556 and then against some of her dividend income – £4,184 of dividends.
“These all amount to £11,500 and so it means that she does not have enough taxable savings income to be able to start using her personal savings allowance.”
Ordering her taxes in this way for the 2017-18 tax year would mean an income tax liability of £744, said Mr Springett.
However, he pointed out that HMRC gives individuals the ability to select
‘The order in which HMRC taxes your incomes is not always the best’
which income they want to be taxed first in order to maximise their use of allowances. By applying tax to her pension and then dividend income first, to count towards her personal allowance, and then making use of the personal savings allowance for some of her remaining savings income, Mrs Scott can cut her tax bill to £478 for 2017-18 – £266 less.
For the 2018-19 tax year, when the dividend allowance is cut, Mrs Scott’s tax bill will rise to more than £700, or more than £900 if she followed HMRC’s defaults, said Mr Springett.
“HMRC has acknowledged that its self-assessment tax calculation guide does not always give the most beneficial outcome to which the taxpayer is entitled,” he said.
“It is unclear as to how much help it will be giving to those affected so that they do not pay more than they ought to.”
Mrs Scott said: “I can’t be the only person caught in this situation, there must be more like me trying to negotiate this complicated system.”