Dividend tax explained

What is dividend tax?

If you own shares in a company or in collective investment products such as unit trusts or OEICs, you could receive the returns in the form of a capital gain or dividends. Both of these are subject to taxation.

Capital gain

The value of the shares or units may grow between the time you buy them and the time you sell them. This is known as a capital gain and is potentially liable to capital gains tax.

Dividends

The company you own shares in may declare a dividend, which is a payment (usually declared annually or twice yearly) to shareholders or investors. This dividend payment is a form of income and could be subject to income tax at the dividend tax rate.

What is the dividend tax allowance?

The dividend allowance is reducing to £1,000 in the 2023/24 tax year and will be halved again to £500 in 2024/25.  Gains within this allowance will pay no tax.

What is the tax rate on dividends?

Dividend income is added to the total of all your other income and the tax rate payable will depend on what income tax bracket the dividends fall into.

On 6 April 2022, dividend tax rates rose as a result of the introduction of the Health and Social Care Levy. The current rates are as follows:

How do I calculate how much dividend tax I need to pay?

1. Add together all your taxable income, starting with non-savings income (for example, your salary, pension income, rent), then savings income (such as interest on deposits) and finally all your dividend income. Tax-free income, such as income from ISAs, tax-free cash from pensions and non-taxable benefits can be excluded, but dividends that fall within the dividend allowance and interest within the savings allowance should be included. Although income within those allowances is not liable to tax, it still needs to be included when calculating how much of the dividends fall into the different tax bands, how much of any capital gains fall into higher-rate tax, whether your personal allowance is reduced because of income exceeding £100,000 and whether any child benefit payments should be reduced.

2. Next, work out the amount of dividends that fall into each of the different tax bands.

3. Finally, work out the tax paid on each band and add the results together. Dividends in excess of £1,000 are subject to the rate of tax applicable to the band they are in (see table above).

The above figure will not necessarily show the total financial impact of receiving dividend income. An increase in your income, whether it is because of dividends or something else, may result in a reduction in any child benefit you may receive, the loss of your personal allowance or a greater capital gains tax bill depending on the level of your other income and your personal circumstances.

A professional adviser will be able to help you with this calculation, so you might want to consider seeking additional advice.

Example calculation

Mr A has a salary of £45,000 and £270 of interest on his deposit account. The tax on this is paid via PAYE through his company. This tax year, he will receive dividends of £12,000 from some shares that he recently inherited. He wants to know how much money he should set aside to cover the additional tax he will have to pay due to the dividends.

Answer

His salary uses up his personal allowance of £12,570 and part of his basic rate band (up to £50,270).

The interest uses up another £270 of the basic rate band but it is not taxable as it is within the personal savings allowance for £1,000.

Mr A’s remaining basic rate band for the tax year is £5,000 (£50,270 - £45,000 - £270 = £5,000).

The first £1,000 of his dividends are not taxable as they are covered by the dividend allowance but they do still use another £1,000 of his basic rate band, leaving £4,000 still to use.

The tax on the remaining dividends is therefore:

£4,000 x 8.75% = £350

£7,000 x 33.75% = £2,362.50

Total = £2,712.50

What type of dividends are not taxable?

Dividends are taxable whether they are paid out or not and accumulating or reinvesting them will not reduce your tax bill.

There are some tax wrappers that can shelter dividends from tax. Dividends paid or accrued within ISAs, pensions and Venture Capital Trusts (VCTs) are exempt from income tax.

How can I reduce the impact of dividend tax on my investments?

There are several things you can do to mitigate your dividend tax liability.

ISAs

Using your ISA allowance annually is key. ISAs are extremely tax-efficient. Everything held within an ISA grows free from income tax (including dividend payments) and capital gains tax. Because of these generous savings, there is an annual limit on how much you can pay into an ISA each tax year. This is currently set at £20,000. Therefore, it is usually wise to make sure that you maximise your allowance where possible before the end of any given tax year.

While they do have a number of tax benefits, it should not be overlooked that ISAs are a form of investment and you could get back less than you contribute. They also form a part of your estate for inheritance tax purposes when you die.

Pensions

Maximising the amount you invest in your pension can be important too, as pension investments grow free from capital gains tax and income tax. Pension contributions are limited by the annual allowance, and you also need to take account of all of the pensions you have paid into personally or through your employer. Pensions are highly tax-efficient, but it is worth seeking professional advice before increasing your pension contributions to ensure that you don’t exceed any limits. Also, remember that you cannot access your pension until you reach the age of 55 (increasing to 57 in 2028). As with ISAs, pensions are also an investment and you may receive less money than you have paid in.

Venture Capital Trusts (VCTs)

VCTs work by investing in young companies which are potentially more volatile and prone to failure. They are therefore considered to be higher risk investments. In exchange for the greater risk they pose, they offer a number of generous tax benefits in addition to tax-free dividends. No capital gains tax is payable when you sell the VCT and on investments of up to £200,000 per tax year, there is a 30% income tax rebate available (if you have paid the amount of tax being rebated and have the VCT for a minimum of five years). Please bear in mind that because of the level of risk involved, VCTs are not for everyone. They are only suitable for UK resident taxpayers who can tolerate higher risks and have a time horizon of more than five years.

Bonds

Investment bonds can be used to defer tax and simplify tax reporting. However, they are liable to income tax on all their returns (capital and growth) at 20%, 40% or 45% rather than capital gains tax at 10% or 20%. It is important to consider how you will mitigate this liability on encashment before investing in a bond. Tax can often be mitigated on a bond by deferring the taxation to a point where you can take the proceeds in a tax efficient way, so your exit strategy is extremely important. Bond taxation is intricate and again, taking professional advice is sensible.

Transfer of ownership

If you are married or in a civil partnership and your husband, wife or civil partner is in a lower tax bracket, it could make financial sense to transfer the share ownership to them via an inter-spousal transfer, as the amount of dividend tax chargeable could be significantly less than if they stayed in the higher earner’s name.

Although mitigating tax wherever possible is usually advisable, it is worth saying that even after the increases to dividend tax rates in April 2022, dividend tax rates are less than the tax rates on almost all other taxable income, such as salary, pension income, rental income and savings interest, which is taxed at 20%, 40% or 45%. Investments that are liable to dividend tax also produce capital gains, which will allow you to use your capital gains tax allowance. Capital gains tax on investments (other than residential property) is only payable at 10% for basic rate taxpayers, or 20% for higher and additional rate taxpayers.

How do I pay dividend tax?

If your dividend income exceeds the allowance, you can contact HMRC to either pay the bill or ask them to amend your tax code. Alternatively, you could complete a tax return, which is reasonably simple to do using HMRC’s online system. If your dividend income is more than £10,000, you will need to complete a tax return regardless.

Talk to Evelyn Partners about dividend tax

If you have any questions about dividend tax and the impact it could have, one of our experts can help you. Book a no-obligation, initial consultation online or call us on 020 7189 2400.

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Examples of how tax or tax relief may apply are based on our understanding of current tax legislation. Whether any tax will be payable, at what level it is charged and whether you qualify for tax relief will depend upon individual circumstances and may be subject to change in the future.