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Alistair Cunningham: Dividend allowance cut is a kind of stealth tax

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The latent pedant in me has big issues with the term “tax-free” when applied to dividends.

Most dividends received by UK investors from UK companies have suffered a 20 per cent corporation tax liability. Corporation tax will soon fall to 19 per cent, and at a time so distant as to effectively be make-believe (after the general election) it will fall further to 17 per cent. The fact remains a dividend should be considered, by many, to be “tax-paid”.

This is why the introduction of the 7.5 per cent dividend charge from April 2016 was unfair, and the latest move to reduce the dividend allowance from £5,000 to £2,000 is even more unreasonable.

In terms of the relative tax paid, I have no doubt this will hit investors harder than the intended target of the “avoidance” measure: owner-managed businesses, particularly personal service companies.

Any company that is trading (and indeed this could apply to investment companies) will likely have earnings of tens of thousands. The stereotypical contractor could, for example, bill £100,000 in fees each year, add their spouse as a 50 per cent shareholder, possibly children and, as a worst-case scenario, see each of these shareholders pay an additional £225 when the dividend allowance falls to £2,000.

Given the avoidance of 40 per cent income tax by the primary worker and various reductions of 13.8 per cent for employer and 12 per cent for employee National Insurance, this is small fry.

But the retired individual with a share portfolio of £200,000 that is lucky enough to enjoy a dividend yield of 3 per cent will see their net dividend fall from £5,925 to £5,700 – this is an increase in their taxation by 500 per cent.

In the Budget the Chancellor also took the opportunity to increase Class 4 National Insurance contributions. The first issue with this decision is that increasing what is essentially a tax on the self-employed will simply encourage more individuals into corporate structures. Remember, any increase in national insurance of more than £225 is not offset by the changes detailed above to dividend taxation.

The second issue is one of fairness. With the abolition of Class 2 National Insurance anyone earning under £23,000 is still better off under the new self-employed rules compared with the current regime.

Profits of £23,000 equate to around £1,500 of National Insurance for a self-employed individual under both pre-2018 and post-2018 rules. In comparison, an employee on the same salary will contribute in excess of £3,800 to the Treasury. Above this level the difference is even more stark, with an employee on £32,000 (the example Philip Hammond used) paying over £6,000 in National Insurance between them and their employer, with the self-employed figure being less than half this, even when the final 11 per cent rate comes in from 2018.

As advisers we will still see our owner-managed business clients extracting profits in the broad tax-efficient priority order of: expenses, then pensions, then dividends, benefits where relevant, and only the lowest feasible level of salary or bonus. Naturally this is only a rule of thumb, and does not take into account a sale or other liquidation event, but the new rules do little to change this.

Because of this, I am left with two conclusions. The first is the change to dividends is an effective stealth tax on those with non-cash, non-Isa investment portfolios. It is perverse that, assuming no other taxable income, an individual can have in excess of £1m in cash without tax to pay, but probably only a few hundred thousand pounds in investments (and how much will it cost for all the extra self-assessment and unintentional evasion?).

The second is that now benefits for the self-employed are in broad harmony with employees, why will they continue to enjoy half the National Insurance, which is essentially just a tax on earned income?

Alistair Cunningham is director of Wingate Financial Planning

He will be joining us at Money Marketing Interactive as a speaker on May 18th. 

Click here for Money Marketing’s Budget coverage in full

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