- Dividend tax hike of 1.25 percentage points
- Company directors and sole traders hit hardest
Investors who draw income from funds held outside of tax-free individual savings accounts (Isas) or self-invested personal pension (Sipp) wrappers face a significant hike in tax on dividend payments of 1.25 percentage points from April next year, as the government seeks to raise additional revenue to cover higher spending on social care and the NHS over the next three years.
Combined with a matching rise in National Insurance contributions, the move is expected to deal the hardest blow to contractors, sole traders and company directors who draw dividends as income from their businesses. In addition, up to 1m retirees still in some form of employment will have to pay NI contributions on their earned income for the first time.
For anyone taking home more in dividends than the £2,000 taxable allowance, the rates will rise to 8.75 per cent for basic-rate taxpayers, 33.75 per cent for higher rate and 39.35 per cent for additional rate payers. As income from stock-and-shares Isas remains tax-free, shareholders who take full advantage of their allowances will continue to enjoy those benefits. It is estimated that the tax hike on dividends will raise about £600m of additional revenue.
Divisions and splits
The move on dividends and National Insurance has created an emerging split between directors and shareholders. Such divergence came to the fore as industry bodies reacted to the news.
The Investment Association, which represents UK shareholder investment groups, told Investors' Chronicle that “getting social care right is vitally important, but we also know that having a tax system that provides certainty and encourages saving for the longer term is equally vital. Therefore, any changes to the rate of dividend taxation and possible impact on the nation’s savings culture would need to be carefully considered and we’ll be working closely with the government on these issues”.
By contrast, the Institute of Directors was much more forthright. In the words of chief economist Kitty Ussher, “this is an extraordinary time to be adding additional burden to business and the cost of employing staff, just as it looks to recover from the pandemic. It smacks of political opportunism, exploiting public sentiment at the expense of some of the most productive and entrepreneurial segments of the economy”.
The most cogent analysis of the situation was by the Institute for Fiscal Studies (IFS). It noted that while the dividend rise was material for people on the highest incomes, the increase in National Insurance contributions would have a much greater unintended effect.
“The fact that National Insurance contributions are not levied on income from bank accounts, dividends or rental property means that they do not discourage saving and investment," the IFS said. "On the other hand, increasing NICs rates would exacerbate the incentive for people to work through their own company, rather than as employees, so that they could take their income as dividends rather than salary.” In other words, it is not an effective raid on the tax advantages that the self-employed enjoy, which has long been a goal of the Treasury but has been consistently blocked in Westminster.
The relatively paltry sums that the dividend tax rise would raise are illustrated by the IFS estimates on how much higher national insurance contributions would bring in. “Across the UK, increasing all rates of employee, employer and self-employed NICs by one percentage point would raise around £10bn a year in the medium run (assuming employers passed the increase in employer NICs onto workers in the form of lower earnings); around £8.5bn of that would come from England.”
