Preparing for the dividend tax changes

In April 2016, the Government replaced the dividend tax credit with a new tax-free dividend allowance of £5,000. This means that you don’t pay tax on the first £5,000 of dividend income. Of course dividend payments from ISA’s remain unaffected and are not taxed. However, Chancellor Phillip Hammond has announced plans to scrap the current £5,000 allowance and instead replace it with a £2,000 dividend allowance by 2018 in an effort to raise up to £900m. This would result in the average dividend tax payment increasing by £315.

With current yields for many UK equities being reasonably high compared to global equities, those investors with more than around £50,000 invested outside the ISA in UK equities (such as FTSE 100 stocks) in particular may be affected by the new dividend tax rules. In fact, should this law come to pass, it is estimated that up to 2.3m individuals will be affected.

Given the potential unsustainability of dividends for some of the major players in the UK market, it is possible that UK investors will look at funds that invest in companies that are more growth orientated. Whilst dividend yields from such companies may not be as high as others, they often have qualities that set them apart from their peers such as strong competitive advantages. Perhaps investors will look favourably on capital gain, especially if it is replacing lost income yield. Additionally, the Capital Gains Tax allowance of £11,300 for the 2017/18 tax year means that capital gains will potentially face lower tax consequences than the dividend tax allowance.

Looking to the future, it is not unreasonable to consider the fact that the Government could choose to further reduce or even remove the dividend tax allowance for holdings outside of the ISA. Therefore, considering your options and planning your investments ahead of time is a prudent move.

- uploaded - 6 june 2017

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