Planning for the dividend allowance cut

The dividend tax allowance cut has reappeared in the September 2017 Finance Bill, reducing the level from £5,000 to £2,000 from April 2018, despite hope that it would not go ahead.

At present, individuals pay no tax on the first £5,000 of dividends they receive, under rules introduced in April 2016. Dividend income above £5,000 is taxed at 7.5% for basic rate taxpayers, 32.5% for higher rate taxpayers and 38.1% for additional rate taxpayers. These rates remain unchanged.

The £3,000 cut in the allowance will leave shareholders who receive more than £2,000 of dividends worse off by up to an annual £225 (basic rate), £975 (higher rate) or £1,143 (additional rate) depending on their income. Those likely to be hardest hit are director/ shareholders who take remuneration from their company mainly in the form of dividends. For a couple who share the running of their company, the ‘loss’ in the figures above is doubled to £450, £1,950 or £2,286 depending on their tax rate.

Dividends remain advantageous compared with salary for basic rate taxpayers because of the lower income tax rate - 7.5% rather than 20% - and the employee’s national insurance contributions (NICs) of 12% and employer’s NICs of 13.8% on salary or a bonus. If you pay tax at the higher or additional rate, however, the effective rate of tax on dividends is only about 3.6% below that on salary, taking NICs into account as well.

Company owners who have not made full use of the £5,000 dividend allowance in 2017/18 should make up the difference by 5 April 2018, if they are in a position to do so. Remember that a company can only pay a dividend if it has enough reserves to cover the payment.

Also adversely affected by the cut in the dividend allowance will be anyone who relies on income from their investment portfolio to supplement their earnings or, in many cases, their pension. If you currently receive more than £2,000 in dividends, you might benefit from switching to investments that give capital growth rather than income.