Andy Woollon looks at dividend tax changes and concludes advice is an essential part of the process...
By the time you read this article, UK interest rates will have been frozen at 0.5% for almost seven years.
In that time, cash savers and investors have turned to other income-producing assets such as equities in order to benefit from dividends - whether for the attractive yields available or the benefits of reinvested income.
At the same time, UK companies have gone from strength to strength and UK dividend payments hit all-time highs of £97.4bn in 2014, according to the Capita Asset Services UK Dividend monitor.
Of course, every dividend paid comes with a non-reclaimable 10% tax credit that fulfils basic rate tax (BRT) and with the need for the Chancellor to balance UK plc's accounts, the temptation (as with previous Chancellors) to fiddle with dividend taxation was just too much to resist.
Who does it affect?
So from 6 April 2016, the dividend income taxation changes will apply dividends paid by:
- UK companies (i.e. direct shareholdings) and
- UK authorised mutual funds (Unit Trusts and OEICs) which are taxed as dividends (more than 40% invested in equities), whether Accumulation or Income units.
While only 15% of those who receive dividends will be worse off (according to the Chancellor), they are more likely to form a higher percentage of your client bank because in practice it will affect:
- Business owners remunerating themselves by dividends
- Investors holding UK stocks paying dividends
- Individuals and trustees invested in mutual funds (outside of an ISA or pension) that are taxed as dividends
And where there is a combination of these, more clients could be impacted and they are likely to be your HNW clients with larger assets under advice, paying higher advice charges.
Dividends received via investments in an ISA, pension or VCT continue to be exempt and investment bonds (particularly onshore) are subject to chargeable event legislation and not dividend taxation, so will increase in favour, specifically for trustees.
Non-taxpayers (NT) 0%
Basic rate taxpayers (BRT) 7.5%
Higher rate taxpayers (HRT) 32.5%
Additional rate taxpayers (ART) and trustees (RAT) 38.1%
The non-reclaimable 10% tax credit is being scrapped, putting an end to grossing-up and the fulfilment of BRT.
However, this will be replaced by a new £5,000 personal dividend allowance meaning the first £5,000 of dividends will be tax-free for all investors, except trustees, with net dividends in excess of this being charged at the new (increased by 7.5%) dividend tax rates shown in the table.
However, the key point and problem is that clients will continue to receive the same amount of dividend and so could be blissfully unaware of the potential increased tax consequences through their tax return in the following tax year. And just how many clients actually understand the dark art of dividend tax grossing-up calculations?
Winners and losers
If we do a comparison between this and next tax year for taxpayers receiving over £5,000 of dividend income, then after the increased taxation, they will actually be worse off as follows: 7.5% for BRT, 10% for HRT and 10.8% for ART/trustees.
How many clients would be happy with a reduction in net income of up to almost 11% and, crucially, not being aware of it until they pay increased dividend tax through self-assessment the following tax year when it's too late to do anything about it?
The table below shows the winners and losers and while it may take a large investment to generate these levels of dividends if some or all of the dividend allowance has been used elsewhere (e.g. a business owner paying themselves by dividends) then the higher rates of dividend tax will be paid.
So there is a clear benefit for HRT/ART with dividends up to £5,000. But for BRT and small business owners remunerating themselves by dividends in excess of the dividend allowance, as well as trustees of discretionary trusts, they will all be worse off.
However, it also makes dividends the most attractive form of income for those worried by tax thresholds and tax traps such as the loss of child benefit from £50,000; personal allowance from £100,000 and the new tapered pension annual allowance from £150,000. Put simply, £5,000 of dividend income is equivalent to £6,250 of gross earnings and/or savings interest for a BRT, which could make the difference between exceeding tax thresholds and incurring tax traps.
So when is an allowance not an allowance?
When it's the new dividend allowance (and for that matter, the new personal savings allowance). Typically, allowances have reduced taxable income e.g. the personal allowance and, therefore, it's not unreasonable that clients may expect that dividends received within the dividend allowance would also not count towards taxable income.
If clients do expect this they are wrong. Dividends received within the dividend allowance still count towards taxable income and actually reduce your BRT/HRT tax band, which potentially pushes other income into the HRT/ART bands. So it is in effect a floating ‘zero-rate tax band for dividends' and the HRT threshold in 2016/17 will be £43,000 and not £48,000 as many clients may mistakenly believe.
Clearly there are many factors to consider and the old adage of ‘not letting the tax tail wag the dog' continues to be true, but just focussing on the tax planning aspects, it will be the availability of the right allowances/tax bands against the right income at the right time that will be beneficial to clients.
For corporate clients or business owners remunerating themselves by dividends (the main focus of the tax changes), they may consider with their accountants, boosting dividend payments in 2015/16 or paying dividends to a spouse or civil partner in 2016/17 to utilise their dividend allowance.
They could also consider either the business or themselves making pension contributions up to available annual allowances - with the tax relief for individuals (currently) obtained by extending the BRT band, which in turn provides headroom to pay further dividends at BRT.
For investors, they can utilise the normal practices of reviewing existing fund and share portfolios, splitting investments/income between spouse or civil partner to utilise their allowances, maximise use of exempt wrappers, shelter equity funds in onshore bonds for those worried by thresholds/tax traps and maximise pension contributions to extend the BRT band.
For trustees of discretionary trusts, who are hardest hit of all, onshore investment bonds investing in equity funds increase in favour due to the fact that dividend income is exempt, as well as many of the other well-known benefits of investment bonds in trust.
The use of platforms will be essential in helping support you managing clients' investments in a tax-efficient way and therefore as part of your due diligence, you may wish to consider whether:
- The tradeable funds list shows the fund taxation basis and yield, saving time having to research fund factsheets
- All payments in/out (including tax relief) are pre-funded to reduce time out of the market
- Client and spouse or civil partner accounts are aggregated together for lower overall charges
- There is a phased investment facility to help smooth the current volatility in equity markets
- An option exists to protect the client from downside investment risk should they die in the early years
- A full range of investment/pension planners and tools are available to monitor the clients portfolio in line with their attitude to risk/capacity for loss and objectives?
The new dividend tax changes are complicated and clients will need professional advice from qualified advisers in order to minimise tax and maximise returns, so this is a great opportunity to demonstrate to clients the value you can add.
Andy Woollon is wealth specialist (national accounts) at Zurich
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