One of the most significant announcements made by the Chancellor Philip Hammond in the recent Spring Budget was the change to the amount of tax-free dividends that can be received by both company directors and shareholders. From April next year, the current amount of £5,000 will decrease to just £2,000. Whilst this is set to raise an extra £930 million of revenue for the Treasury in 2021/22, making it the biggest tax earner announced in the Budget, it has been criticised for demotivating growth and investment for businesses.
The current rules were introduced in April 2016 and mean that an individual receives a tax break on the first £5,000 of annual income from dividends. Anything above that is taxed at 7.5% for basic-rate taxpayers, rising to 32.5% for those on the higher rate and 38.1% for those paying additional rates of tax.
The chancellor has described his changes as addressing the unfairness of the current dividend allowance put in place by his predecessor, George Osborne. However, as many small traders pay themselves through dividends, alongside taking a salary from their company, the move has been seen as punitive towards those who have decided to strike out on their own in business.
The reduced tax-free dividend rate is also set to impact those who have reasonably sized stocks and shares investments outside ISAs. The Treasury estimates this to be around 1.1 million investors, approximately half of all people affected, and that on average annually they will each lose around £320.
However, there is a positive note for investors thanks to the increase in the ISA allowance. From April this year, the amount is set to rise from £15,240 to £20,000, and all dividends generated within ISAs will still be tax-free. By making smart use of the new allowance, most investors will be able to avoid feeling the effect of the changes to dividend tax.