Dividend taxation is not as widely understood as it perhaps should be. Although business owners and individuals with large share portfolios are among the prime recipients of payouts, others have also been hit in the past.
Labour’s 1997 pensions raid, which ended tax relief on dividends for pension funds, was recouping some £10bn a year as of 2014, according to the Office for Budget Responsibility.
Two decades later and dividend taxation faces another overhaul. While the changes announced by the Conservatives in 2015 and 2017 are less dramatic than Gordon Brown’s, they will have a more significant effect on financial advisers and how they construct portfolios for clients.
Business owners, and company directors in particular, have long used the favourable tax position of dividends to their advantage.
Dividends come in for lower rates of income tax compared with PAYE above the personal allowance, and are not subject to national insurance.
In 2015, the government moved to address what it considered to be an uneven system, but last year’s change in personnel at the Treasury has muddied the waters.
Two years on from George Osborne’s decision to reform personal dividend taxation, his successor Philip Hammond has already taken an axe to the rules, cutting the dividend allowance from £5,000 to £2,000.
System overhaul
The dividend allowance was announced in 2015 as part of Osborne’s broader move to cut back on dividend tax breaks. Introduced in April 2016, the allowance meant the first £5,000 of dividend payments would be free of income tax, but the 10 per cent tax credit was removed in the process. Table 1 shows how these changes affected taxpayers in practice.
Although Mr Osborne claimed this would modernise an ‘arcane’ dividend system, the public response varied. From an investment fund perspective, the switch transferred the potential tax liability from providers to clients, but some welcomed the change in the hope that dividends being paid gross would result in a higher distribution. In reality, the tax on net dividends previously received by investors was very much viewed as notional, meaning that a larger dividend payment was perhaps wishful thinking.
Rachael Griffin, head of trusts and technical solutions at Old Mutual Wealth, says of the original changes: “It felt like a simplification. At the time there was a feeling it would actually cover most people who were receiving dividends, and therefore wouldn’t have to fill in any tax returns or have any further complications.”
However, others disagree. Danny Cox, head of communications at Hargreaves Lansdown, says: “Clearly, the target was small businesses, but investors got caught up in the aftermath.”
Unintended consequence
