Twice as many to be caught by dividend tax – are you among them?
Don't invest unless you’re prepared to lose all the money you invest. This is a high-risk investment and you are unlikely to be protected if something goes wrong. Take 2 mins to learn more.
Estimated reading time: 2 min
Due to the potential for losses, the Financial Conduct Authority (FCA) considers this investment to be high risk.
What are the key risks?
- You could lose all the money you invest
- If the business you invest in fails, you are likely to lose 100% of the money you invested. Most start-up businesses fail.
- You are unlikely to be protected if something goes wrong
- Protection from the Financial Services Compensation Scheme (FSCS), in relation to claims against failed regulated firms, does not cover poor investment performance. Try the FSCS investment protection checker here.
- Protection from the Financial Ombudsman Service (FOS) does not cover poor investment performance. If you have a complaint against an FCA-regulated firm, FOS may be able to consider it. Learn more about FOS protection here.
- You won’t get your money back quickly
- Even if the business you invest in is successful, it may take several years to get your money back. You are unlikely to be able to sell your investment early.
- The most likely way to get your money back is if the business is bought by another business or lists its shares on an exchange such as the London Stock Exchange. These events are not common.
- If you are investing in a start-up business, you should not expect to get your money back through dividends. Start-up businesses rarely pay these.
- Don’t put all your eggs in one basket
- Putting all your money into a single business or type of investment for example, is risky. Spreading your money across different investments makes you less dependent on any one to do well.
- A good rule of thumb is not to invest more than 10% of your money in high-risk investments.
- The value of your investment can be reduced
- The percentage of the business that you own will decrease if the business issues more shares. This could mean that the value of your investment reduces, depending on how much the business grows. Most start-up businesses issue multiple rounds of shares.
- These new shares could have additional rights that your shares don’t have, such as the right to receive a fixed dividend, which could further reduce your chances of getting a return on your investment.
If you are interested in learning more about how to protect yourself, visit the FCA’s website here.
Having promised not to raise taxes on “working people” in the upcoming Budget on 30 October, might Chancellor Rachel Reeves look to squeeze more out of dividend taxpayers instead, to help plug a £22 billion “black hole” in the country’s finances?
HMRC has already benefitted from increased dividend tax receipts in recent years, paid by a growing number of people. This is partly due to the tax-free allowance being progressively whittled down from £5,000 (in 2017/18) to the current £500 – and exacerbated by frozen income-tax bands and inflation pushing taxpayers into higher tax bands.
It’s estimated HMRC will collect some £18 billion from roughly 3.6 million dividend taxpayers this tax year – nearly twice as many people as were liable to pay the tax in 2021/22.
Important: The information on this website is for experienced investors. It is not a personal recommendation to invest. If you’re unsure, please seek advice. These investments are for the long term. They are high risk and can fall as well as rise in value: you could lose all the money you invest. Tax rules can change and benefits depend on circumstances.
Is there a more tax-efficient way to receive dividends?
For experienced investors concerned about the way things are going, there are tax-efficient investment options available – including ones that offer tax-free UK dividends and tax-free growth (see below).
If lowering your overall tax bill is a priority, there are also investments that offer generous tax reliefs, in addition to tax-free growth (see below).
Each of these types of investment provides a different mix of potential benefits, risks and reliefs that could meet different investors’ requirements.
For instance, with EIS and SEIS, you could also apply for relief against capital gains tax from gains made elsewhere, and your investment should be inheritance tax free if you hold it at least two years and on death.
This is a brief outline based on current rules: there are detailed conditions and rules you should consider carefully before investing. Please also bear in mind that you should not “let the tax tail wag the investment dog”. These investments are high risk and you should not invest simply for tax reasons, but make your decisions based on the merits of the investment. Tax rules can change and benefits depend on circumstances.
How to receive tax-free dividends
Two types of investment that qualify for tax-free dividends, alongside other tax reliefs, are ISAs and Venture Capital Trusts (VCTs).
ISAs – tax-free dividends and growth
When you invest in a Stocks & Shares ISA any UK dividends paid by the underlying shares are free from tax and do not count towards your personal dividend allowance. Moreover, any income you take is free from UK income tax and gains should be tax free.
Every year, you have an ISA allowance, currently £20,000, to be used by the last day of the tax year, 5 April.
If you want to subscribe to an ISA and leave the hassle of selecting the investments to us, our Managed Portfolios – the Wealth Club Portfolio Service and the Quality Shares Portfolio – could be an option for you to consider. You can also make transfers from an existing ISA.
VCTs – tax-free dividends and growth, up to 30% income tax relief
Akin to investment trusts, VCTs are listed on the London Stock Exchange and typically invest in a portfolio of 30-100 young and ambitious companies. Returns are normally in the form of dividends, which you can re-invest or have paid out tax free. Most VCT state their target dividend – usually around 5% of the trust’s NAV – although dividends are variable and not guaranteed.
In addition, when you invest in VCTs you could claim up to 30% income tax relief. The maximum you can invest in VCTs per tax year and receive tax relief on is £200,000.
Because VCTs invest exclusively in small, young companies, which are more likely to fail than larger and established businesses, the risks of VCT investing are higher than more mainstream stock market investments.
How to get income tax relief
Several types of investment offer different levels of tax relief. As a rule of thumb, the riskier or the more restricted the investment, the more generous the tax relief.
Here we give a brief overview of pensions and the government-backed Venture Capital Schemes: VCTs, the Enterprise Investment Scheme (EIS), and the Seed Enterprise Investment Scheme (SEIS).
Pensions – up to 45% tax relief and tax-free growth
If you are eligible, contributing to a pension offers some of the most generous tax reliefs – including up to 45% tax relief on the way in and tax-free growth while you’re invested. A £10,000 contribution could effectively cost a higher-rate taxpayer as little as £6,000, reducing to £5,500 for a top-rate taxpayer. Read more on how pension tax relief works »
If you want to contribute to a pension and leave the hassle of selecting the investments to us, our Managed Portfolios – the Wealth Club Portfolio Service and the Quality Shares Portfolio – could be an option for you to consider. Both are available within our SIPP (Self Invested Personal Pension).
VCTs, EIS and SEIS – 30% to 50% income tax and capital gains tax relief
All three invest in dynamic and ambitious young businesses. These are an important engine of the UK economy but are also higher risk and more prone to failure than their larger counterparts. To help mitigate these risks and to encourage investment, the government offers valuable tax reliefs.
VCTs
- Up to 30% tax relief – save up to £60,000 on your income tax bill when you invest in newly issued VCT shares
- Generous allowance – invest up to £200,000 per tax year
- Tax-free dividends – no need to declare VCT dividends on your tax return
- Tax-free growth – no CGT on gains
EIS
- Up to 30% income tax relief – up to £3,000 saving on a £10,000 investment either against this tax year's bill or carry back to the previous tax year
- Very generous allowance – up to £1 million per tax year (or £2 million if at least £1 million is in knowledge-intensive companies)
- Tax-free growth if you have also claimed the income tax relief – no CGT on gains
- Capital gains deferral – defer capital gains from other investments, potentially indefinitely
- Loss relief – offset any future losses against your income
- Inheritance tax relief – potentially pass on your investment free of IHT (when held at least two years and on death)
SEIS
- Up to 50% income tax relief – up to £5,000 saving on a £10,000 investment either against this tax year's bill or carry back to the previous tax year
- Generous allowance – £200,000 per tax year
- Tax-free growth if you have also claimed the income tax relief – no CGT on gains
- Up to 50% capital gains reinvestment relief – halve the CGT due on gains from elsewhere
- Loss relief – offset any future losses against your income
- Inheritance tax relief – potentially pass on your investment free of IHT (when held at least two years and on death)
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.
Alex Davies
Chief Executive
Alex was a board director at Hargreaves Lansdown, where he worked for 15 years. He was responsible for building Hargreaves Lansdown into the biggest direct-to-consumer SIPP provider in the UK with more than 150,000 clients and over £12 billion under management. He is a keen investor with a portfolio of shares, funds, student property, EIS and VCT investments.