The UK government’s announcement earlier this month that both National Insurance (NI) and dividend tax rates are set to be increased by 1.25% in tax year 2022 / 3 to fund health and social care costs has certainly proved controversial.
Most of the attention has been focused on the rise of NI, given that it was a violation of a Tory manifesto commitment and its impact will be widely felt by employees and businesses alike.
However, raising the dividend tax rate will also be painful, especially for the millions of small business owners across the UK, many of whom earn low wages but pay themselves dividends. Small businesses are the backbone of the economy, but many owners will feel that they are increasingly in the crosshairs of the government.
The rise in dividend tax rates appears to be specifically designed to prevent business owners from trying to mitigate the increase in the NI by potentially reducing the amount they receive in wages, where national insurance is. will apply, in favor of dividends, where this is not the case.
While some may view the government’s move as a fair attempt to counter tax planning, it should be remembered that NI is paid by both the employee and the company. Self-employed workers paying a salary are therefore in reality asked to pay the new social charge twice.
And although dividends are not subject to NI contributions, they are paid out of profits which are subject to corporation tax. Dividends as a source of income for small business owners are therefore effectively double taxed.
The increase, which will see the dividend tax rise next year from 7.5% to 8.75% for taxpayers at the base rate, from 32.5% to 33.75% for those taxed at the higher rate and 38.1% to 39.35% for taxpayers at the additional rate, is just the latest raid on dividends.
In 2018, the UK government reduced the annual allowance on which dividend income can be received tax free from £ 5,000 per person to £ 2,000.
The combination of the reduction in the allowance and the impending increase in dividend tax rates means that a base rate taxpayer receiving £ 10,000 in dividends will have increased from £ 375 between 6 April 2016 and 5 April 2018, when the allowance was higher, to £ 700 from the following tax year.
Likewise, a higher rate taxpayer with £ 10,000 in dividends will end up paying £ 2,700 in tax per year, up from £ 1,625 before April 5, 2018. This represents an effective increase of 86.7% in the amount of tax paid on £ 10,000 of dividends. for the basic rate taxpayer and 66.1% for the higher rate taxpayer within four years.
While the squeeze will be hard hit by owners of small private businesses, investors in publicly traded companies, whether through stocks or equity funds, could also be affected if they received more than £ 2,000 in dividend income. However, unlike owners of private company stocks, they have more leeway to ease the tightening of the noose.
Those who own publicly traded stocks or equity funds in a tax environment should first consider migrating them to Individual Savings Accounts. This is a process known as “Bed and ISA” and involves selling the stocks or funds and buying them back with an ISA, where future dividends will be completely exempt from tax. This is not an option open to private business owners, as unlisted companies cannot be held in an ISA.
In doing so, care should be taken not to incur capital gains tax on the sale of the investment before redeeming it again. Up to £ 12,300 of profit can be crystallized each fiscal year, without capital gains tax, and each adult can invest up to £ 20,000 in an ISA.
Another great option for married couples and civil partners is to trade equity and equity funds to maximize tax efficiency.
These “transfers between spouses” do not trigger a taxable event. This can help married couples and civil partners use two sets of dividend allowances, two sets of capital gains allowances, and two ISA allowances to migrate dividend-paying stocks and investments out of tax reach.
Even when investments remain in a potentially taxable environment, as ISA allowances are already fully maximized, transferring them to one of the spouses who may be subject to a lower tax rate can help reduce the overall tax liability.
Where a person is not subject to tax, in addition to using their £ 2,000 dividend allowance, dividend income may be charged against their annual tax-free personal allowance of £ 12,570.
A little family financial planning can go a long way in protecting dividends from the grip of HM Revenue & Customs.
Jason Hollands is managing director of wealth manager Tilney Smith & Williamson.