December 2017


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Beneath the surface of the dividend allowance

12 December 2017

When an allowance is really a nil rate band, calculating income tax payable where dividend income straddles the basic and higher rate tax bands, becomes more complicated. Barry Foster, technical sales manager, Utmost Wealth Solutions, examines the dividend allowance using a case study example.

Old news now of course but since 6 April 2016 the notional (and non-reclaimable) 10% tax credit is no longer available in respect of UK dividends. The Dividend Allowance was also introduced at the same time.

Taken in isolation, these developments may have been welcome as the tax credit just made calculating liability to income tax more complicated than it needed to be and, as for the dividend allowance, who doesn’t like a tax allowance!

However, these measures were not introduced in isolation, they were accompanied by an increase in the actual rates of tax due on dividend income.

Indeed, there was much discussion about “when an allowance is not really an allowance”. That is to say there was some confusion initially about whether dividend income within the dividend allowance was taxable income or not. It is of course taxable income, meaning that the allowance is really a nil rate band: income within the allowance is taxable but charged at 0%.

This is not just a semantic point. Income charged at 0% is not the same as income that is non- taxable, such as income sitting within the personal allowance, and it is important to understand the distinction when establishing whether an individual is a higher or basic rate tax payer for example. This is particularly well illustrated where dividend income straddles the basic and higher rate tax bands.


• Davey Dends has pension income of £40,000 & dividend income of £10,000

• His pension income exceeds his personal allowance (£11,500 for 2017/18) by £28,500 and is taxed at basic rate.

• The basic rate band is £33,500 so there is £5,000 basic rate band remaining.

• If the £5,000 dividend allowance meant that £5,000 of Davey’s dividends were non-taxable his remaining £5,000 dividends would sit within the remaining basic rate band and be taxed at 7.5%.

• However, the dividend allowance actually just reduces Davey’s liability to basic rate tax on £5,000 of his dividends to £0 but he still pays higher rate (£32.5%) tax on the other £5,000 as those dividends sit within the higher rate tax band.

Much has already been written about the impact of the withdrawal of the tax credit, the increased tax rates and the dividend allowance including comparisons of the tax liabilities that hypothetical clients would have suffered under the “old” regime compared to the new.

So what happens in April 2018?

We might now think about revisiting this type of analysis because, despite having been pulled from the first 2017 Finance Bill, measures to reduce the dividend allowance have been re-introduced into the Finance Bill(No2) 2017.

The dividend allowance will be reduced from £5,000 to £2,000 from 6th April 2018 potentially increasing the tax liabilities of clients in receipt of dividend income.

So, what does a client do when faced with an increased tax bill, not because their income has increased, but because the tax regime has moved against them? They can of course just “suck it up” and pay the tax or, alternatively, they can consider how else to arrange their affairs in a way that reduces their liability to tax in a way that is not abusive.

Clearly, for those who run their own businesses and have tended to draw profits predominantly in the form of dividends, the reduction in the dividend allowance will probably not be welcome news.

What about those whose dividends are derived from invested wealth?

So when does your client exceed their dividend allowance?

I was wondering what size of portfolio might create a dividend yield of £5,000. Obviously, there is no hard and fast answer to this as it will depend upon the balance of equities and fixed interest securities in the portfolio, the balance of passive trackers and actively managed funds and which equities are held within the equity part of the portfolio etc.

Nevertheless, I thought I would try to get an idea so I “Googled” and ended up on the FTSE website:

At the date of writing this the following yields were quoted;

• FTSE all share 3.62%

• FTSE 250 2.67%

• FTSE 100 3.86%

Using the FTSE all share as the benchmark for a UK equity portfolio with a yield of 3.62%, an equity portfolio of £138,122 will produce a dividend yield of £5,000.

So how does this change in April?

Again using 3.62%, an equity portfolio of £55,249 will produce a dividend yield of £2,000.

Assuming 70% of the client’s portfolio is invested in equities and 30% invested in fixed interest securities this suggests an overall portfolio size of £78,927.

(Whether the £23,678 invested in fixed interest securities will generate more savings income than the client’s starting rate band or personal savings allowance would cover is another matter!)

So, assuming Pensions and ISAs are fully subscribed, do clients with more than circa £80,000 to invest continue to invest into a portfolio creating a dividend yield arising for tax purposes year on year or do they consider a tax deferred alternative?

There is an argument for “parking” future ISA subscriptions in an OEIC portfolio and doing an annual “bed and ISA” exercise and there is also, as you can see, an argument for investing via an investment bond to achieve tax deferral in the accumulation phase with a view to securing a lower tax rate when de-cumulating and realising chargeable gains.

The choice of onshore investment bond or offshore investment bond will likely be driven by the anticipated tax rate in the de-accumulation phase and the availability of allowances and nil rate bands.