In his Spring Budget, Chancellor Philip Hammond reduced the tax-free dividend allowance from £5,000 a year to £2,000 with effect from April 2018.
The change came only a year after his predecessor George Osborne had changed the way dividends are taxed and introduced the £5,000 allowance.
Hammond’s change was designed to raise the amount of tax collected from business owners. Under current rules, they pay a lot less tax on their dividends than they would pay if they took a salary on which not just income tax but National Insurance contributions were payable. It is these business owners who will on average stump up a few hundred pounds a year each in extra tax from 2018-19.
But the change will also affect some individual investors and make life more complicated for millions more. It is one more wrinkle in the tax system. Many people will have to work out if their total dividends exceed £2,000 a year. Some will be able to change their investments so that their dividends fall below the threshold and they don’t pay tax. This may not be a big deal for basic rate taxpayers, who will pay tax at 7.5% on dividends above the threshold, but higher rate taxpayers will have to fork out 32.5% in tax, so it will be worth their while wiggling to avoid this.
Even worse than this change is that the tax system allows the taxpayer to choose which of their allowances are set against which ‘slices’ of their income (pension/earnings, savings interest, dividends). But in the case of dividend tax, the way HMRC allocates the allowances means you’ll pay more tax than you would if you chose the most efficient use of the allowances. It’s likely that only a handful of people will even realise they are overpaying and even fewer will be able to work out how much less tax they could pay if their allowances were used in the most efficient way.