Member Article

How business owners can lessen the impact of divided taxation changes

With the new financial year fast approaching, Paul Gilsenan, Principal of Paul Gilsenan Wealth Management – partner practice of St. James’s Place Wealth Management – looks ahead to the upcoming changes to dividend taxation, and how acting now can lessen their impact.

Changes to dividend taxation in April make it even more important that investors make full use of tax-efficient shelters to create and protect wealth.

When he introduced the new Dividend Allowance in April 2016, it’s doubtful that then-chancellor George Osborne anticipated it would be so short-lived.

The allowance was introduced to encourage people to invest by making the first £5,000 of dividend income earned by shareholders each year tax-free. At the time, the government claimed the new allowance would reduce the tax bill for one million people.

But in March last year, his successor Philip Hammond announced plans to cut the tax-free dividend allowance to £2,000, as of 6 April 2018.

Dividends above the £2,000 threshold will be taxed at 7.5% for basic rate taxpayers, 32.5% for higher rate taxpayers, and 38.1% for top earners.

Who stands to lose out?

Business owners who pay themselves dividends as a more tax-efficient alternative to salary will be hit hardest. After all, the measure was designed to level the playing field between the employed and self-employed.

However, it will also leave some private investors worse off. That includes, perhaps unintentionally, those who are using dividends to help fund their retirement. Many could be pensioners who turned to investing in equities because interest rates were so low.

What can investors do to minimise their dividend tax liability?

Take shelter: that’s the advice from St James’s Place. “Making the maximum possible use of tax-efficient wrappers is a basic step, yet it is the best line of defence against this tax change,” says Tony Müdd, Divisional Director. “Investors with substantial holdings outside of ISAs and pensions should consider moving them into these tax shelters. This could produce capital gains though, so such a move will need to be managed within the CGT allowance of £11,300.”

Assuming a dividend yield of 3.5%, those investors with portfolios worth around £50,000 held outside of these wrappers should still pay no tax on the income generated. As a result, a couple could still hold a significant sum in non-ISA and pension investments, without that sum being subjected to dividend tax.

But there is no doubt that building up funds within ISAs and pensions is the surest way to minimise tax liabilities, and to mitigate the impact of further tax changes.

Making the maximum possible use of this year’s ISA allowance of £20,000 is an obvious starting point, and taking advantage of other tax allowances and exemptions can also make a big difference.

There are also other important factors to consider:

• The personal tax allowance of £11,500 can also cover dividend income, if other income sources add up to less than that amount.
• Assets can be passed between spouses without restriction, which enables full use of both partners’ personal allowance, CGT allowance and reduced dividend allowance.
• It may be possible to generate income as interest rather than as dividends; for example, from bond funds, which might then fall within the tax-free Personal Savings Allowance for interest payments.

The dividend allowance cut illustrates the capacity for tax rules to change regularly. This change underlines the importance of reviewing your personal finances on a regular basis, to ensure that they are arranged as tax-efficiently as possible. The end of the tax year presents an ideal opportunity to check that you are making the best possible use of exemptions and allowances.

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Paul Gilsenan Wealth Management is a partner practice of St. James’s Place Wealth Management. The firm specialises in providing high quality personal advice on wealth management to clients looking to build, protect or preserve their wealth.

This was posted in Bdaily's Members' News section by PSG Wealth Management Ltd .