The £2 billion tax raid on dividends and capital gains – will you be affected?
You might have seen it in the press: the Treasury is expected to collect as much as £2 billion extra in tax and penalties on dividends and capital gains over the next two years. It’s estimated up to a million taxpayers will feel this tax pinch.
This is the result of two sets of changes.
Firstly, the dividend and capital gains allowances have been halved with effect from 6 April. Secondly, income tax thresholds have been frozen – or, in the case of the top rate (45%) of income tax, dropped substantially, from £150,000 to £125,140. This is pushing more taxpayers into the higher and additional rate of income tax and, consequently, the higher rate of capital gains tax.
How could experienced investors save on a substantial tax bill – whilst supporting dynamic young British businesses? Here we look at tax-efficient investments that could potentially help mitigate the impact.
Tax benefits depend on circumstances and tax rules can change. This is a brief outline based on current rules: there are detailed conditions and rules you should consider carefully before investing. There are limits to the amount which can be invested into some of these investments each tax year and minimum holding periods to retain tax reliefs may apply. Decisions should be based on the investment merit, not the tax reliefs alone.
How to save on dividend tax
The annual dividend allowance (the amount before you have to pay tax), was halved from £2,000 to £1,000 this April, and will shrink to just £500 from 6 April 2024.
Once you use the allowance, you pay tax on dividends based on your income tax band. So, if you’re pushed into a higher income tax band, you also pay more tax on any dividends you receive.
Dividends are normally tax free if the investment is held in an ISA, so investors could consider making full use of the yearly £20,000 ISA allowance.
But what if you have already maximised your ISA contributions? In that case, these tax changes could potentially make VCTs more attractive.
Any dividends paid out from VCTs are tax free. So, if a VCT pays a 5% dividend, that means you get 5p for every £1. To match that, assuming the dividend allowance has already been used, a higher-rate taxpayer would have to receive a taxable dividend of 7.55% (8.24% for a top-rate taxpayer). Note: dividends are variable and not guaranteed.
Also valuably, when you invest in a VCT you may claim up to 30% income tax relief.
How to save on capital gains tax
The capital gains tax-free annual allowance has also been halved from £12,300 to £6,000 this tax year, and will be further cut down to £3,000 from April 2024 – reaching the lowest level since 1981.
Once again, ISAs could help as any gains from investments held in an ISA should be tax-free. Other strategies include crystallising losses within the annual allowance or in some cases transferring assets to a spouse.
However, there are also other options that could help experienced investors minimise a CGT liability.
Defer gains with EIS
When you invest any portion of a gain in EIS, you should be able to defer the CGT for as long as the money stays invested – potentially indefinitely. The tax is only payable when you realise your EIS investment, unless you roll that into another EIS investment. You could defer gains realised up to one year before and three years after your EIS investment date. You can invest up to £2 million (if including knowledge-intensive EIS) per tax year.
In addition, any growth is tax-free and the investment should be IHT-free if held for two years and on death. To benefit from the tax-free growth, you must have also claimed the income tax relief: when you invest in EIS you can offset up to 30% income tax relief against your current year’s tax bill or the previous year’s. If things don’t work out as planned, you can offset loss relief against your income tax.
Cut a CGT bill in half with SEIS
The most generous tax reliefs are reserved for investing in the youngest – and therefore highest-risk – companies, under SEIS. When you invest any portion of a gain in SEIS, you could reduce the CGT bill by up to 50%. You may use the relief on investments in the tax year of your investment, or the year before. To use the CGT relief, you must have also claimed the income tax relief (up to 50%) in the same year. You can invest up to £200,000 per tax year.
Any growth is tax free, the investment should also be IHT-free if held for two years and on death, and you could claim loss relief if things don’t go to plan. As with EIS, to benefit from the tax-free growth you must have also claimed the income tax relief.
Wealth Club aims to make it easier for experienced investors to find information on – and apply for – investments. You should base your investment decision on the offer documents and ensure you have read and fully understand them before investing. The information on this webpage is a marketing communication. It is not advice or a personal or research recommendation to buy any of the investments mentioned, nor does it include any opinion as to the present or future value or price of these investments. It does not satisfy legal requirements promoting investment research independence and is thus not subject to prohibitions on dealing ahead of its dissemination.