The Financial Implications of the Cuts to the Dividend Allowance

Further to the November 2022 budget, from 6 April 2023, the Dividend Allowance halves in value, before halving again on 6 April 2024. In this blog, we look at the financial implications of these cuts as well as some ideas to potentially mitigate their effects. This is useful reading for CII R02, R03, R06, AF1, AF4, and AF5 exam revision.

This article is relevant to examinable tax year 2023/24 and is correct as at 18 January 2023.

Dividend Tax: Recent History

In 2015, the government announced that dividend taxation would be reformed from April 2016, introducing a £5,000 Dividend Allowance and setting the rates of Income Tax for dividend income at 7.5% for basic-rate taxpayers, 32.5% for higher-rate taxpayers, and 38.1% for additional-rate taxpayers.

In 2017, the government announced that the Dividend Allowance would be reduced to £2,000 from April 2018.

In 2021, the government announced that the rate of Income Tax applicable to dividend income would increase by 1.25% to 8.75% for basic-rate, 33.75% for higher-rate and 39.35% for additional- rate taxpayers from April 2022.

In 2022, the government announced further reductions to the Dividend Allowance to £1,000 from 6 April 2023 and to £500 from 6 April 2024.

Impact of Changes to Dividend Taxation on Shareholdings

To date, the Dividend Allowance has been a useful planning tool, especially for family companies where family members are shareholders; paying dividends to use any available Dividend Allowance increases the profits that can be extracted tax-free (albeit profits that have already been subject to Corporation Tax).

Let’s take a look at the financial impact of both recent and upcoming changes on a dividend payment of £10,000:

The table illustrates a significant drop in the net dividend income over time:

• In 2016/17, the net dividend represented just under 84% of the gross dividend.
• By 2024/25, it will be just under 68%, with almost twice as much Income Tax being payable than in 2016/17.

Where company profits are more than £50,000, the Corporation Tax increase from April 2023 will reduce the post-tax profits available for distribution as a dividend, and the reduced Dividend Allowance will increase the tax payable by shareholders where those profits are extracted as dividends – a double whammy for some business owners. 

Impact of Changes to Dividend Taxation on Investments

The impact of the Dividend Allowance cuts on investors with direct shareholdings and indirect shareholdings in collectives such as unit trusts, OEICs, and investment trusts is much the same.

However, there may be more scope to reduce their impact by maximising ISA and pension contributions. Dividends within these tax wrappers are not subject to Income Tax and do not count towards the Dividend Allowance.

For couples who are married/in a civil partnership, where one party is using their full Dividend Allowance but the other isn’t, consideration could be given to transferring or sharing ownership of existing investments to enable the other party to use their Dividend Allowance too. This could also save Income Tax where the receiving party is, say, a basic-rate taxpayer and their partner normally pays tax at the higher or additional-rate. To be effective for tax purposes, any transfer must be made outright and must be unconditional.

Over the longer term, a Bed and ISA transaction can be considered as a means of moving existing shares or collective shareholdings into a tax-sheltered environment.

Once these vehicles are maximised, investors could select low-yielding funds to minimise the dividends payable to them or could consider an investment bond.

Grab the resources you need!

If you’re studying for your CII R03 exam, and you don’t want to waste precious time figuring out the calculations, you’ll need to be well prepared. Grab our free taster to try out one of Brand Financial Training’s calculation workbooks for yourself.  Click the link to download the R03 calculation workbook taster now!

Alternatively, you can download a taster for AF1, AF4, AF5, R02, or R06 if you’re revising for any of those exams.