Explained – What do CGT and Dividend Tax Changes Mean for Investors?
Since 2023, investors have been facing higher taxes on their portfolios through dramatic reductions in the dividend allowance and capital gains tax (CGT) exemption. Having already been broadly halved in tax year 2023-24 the allowances will halve once again in April 2024.
Many who will not have had to worry in previous years will therefore be dragged into reporting their income and gains and paying these taxes.
In the rest of this article, I will take you through the changes in more detail and discuss some potential planning implications for those who want to avoid, or reduce, this tax burden under the new rules.
The new dividend allowance and CGT exemption
Taxable investment portfolios are subject to both income tax and capital gains tax. Income tax applies to the income received on an ongoing basis (such as dividends and interest) and capital gains tax applies when an investment is sold to the extent that the amount it is sold for exceeds the amount invested.
However, a suitable level of investment in a taxable portfolio has been relatively tax-efficient in the past as investors have been able to make use of their annual CGT exemption and dividend allowance.
As seen in the table below, on 6 April 2024, both the dividend allowance and the CGT exemption will be around one quarter of what they were in the 2022/23 tax year.
| Year | 2022-23 | 2023-24 | 2024-25 |
|---|---|---|---|
| CGT allowance | £12,300 | £6,000 | £3,000 |
| Dividend allowance | £2,000 | £1,000 | £500 |
For anything over the allowances, the tax rates are as follows:
| Taxpayer | Capital Gains Tax* | Dividends | Income (including interest) |
|---|---|---|---|
| Basic Rate | 10% | 8.75% | 20% |
| Higher Rate | 20% | 33.75% | 40% |
| Additional Rate | 20% | 39.35% | 45% |
*18% and 28% respectively for residential property.
For those who don’t know how taxes on gains and dividends work in practice, the two examples below should help:
The new CGT allowances- illustrated
Jerry invested £5,000 in an equity fund and was pleased to have seen it grow to £10,000. This would mean Jerry had an unrealised gain of £5,000. This is not taxable until the point of sale; Jerry can keep this invested for as long as he wants without paying CGT (although he may have to pay tax on his dividends – see below).
If Jerry were to have fully sold this holding in the 2022/23 tax year, his £5,000 gain would not be taxed, as it would have been under the exemption amount of £12,300. If, instead, he sold it in the 2023/24 tax year, he would still not pay tax, and should still have £1,000 of the CGT exemption remaining.
However, if he were to sell his holding in the 2024/25 tax year, the £5,000 gain would be over his £3,000 exemption, and Jerry would have to pay tax on the £2,000 excess. This would be charged at 10% (or £200) if was a basic rate taxpayer, and 20% (or £400) if he was a higher or additional rate taxpayer.
It is worth noting that if Jerry only sold half of his £10,000 holding, the gain realised would be £2,500, which is under the new exemption. Jerry could then sell the other half in the next tax year and use his new exemption to not pay any tax. Of course, if the investment grows in the meantime and the gain may be over £3,000 and Jerry could still be subject to tax if he sells all his remaining holding in one go.
These calculations assume that Jerry realises no other gains in any of the tax years noted.
The new dividend allowance- illustrated
Tom is a higher rate taxpayer with an equity investment worth £35,000. Assuming a 3% dividend, he may receive £1,050 gross per year. Assuming no change in the value of investment or dividend, if he received this in the:
- 2022/23 tax year, he would have no tax to pay, with this fully covered by the £2,000 allowance.
- 2023/24 tax year, as he was £50 over the allowance, tax should be due at 33.75% of £50, or £16.88.
- 2024/25 tax year, as he was £550 over the allowance, tax should be due at 33.75% of £550, or £185.63.
It is worth noting that even where dividends are accumulated (i.e. reinvested) rather than paid out to the investor, tax is still chargeable.
Financial planning implications of the changes to CGT and dividend taxation
Phasing
Investors who have, or foresee, a need for money which they have invested may want to sell down their taxable investments over time instead of all at once. This may help make use of the CGT exemption each year meaning less of the gains are ultimately subject to tax whilst still raising the funds in good time for the intended purpose.
Setting a CGT Budget
It is important to note that capital gains tax and dividend taxes are still favourable to paying headline income tax rates which might be the case through other products. It is also worth noting that capital gains tax rates are more likely to increase than fall in the future, albeit we cannot predict this. Therefore, there is potentially merit in paying some tax on an ongoing basis. This is further exacerbated by the reduced allowances as it may take many years to manage out gains successfully and the ongoing suitability of the portfolio needs to be considered in the meantime.
Some potential strategies include:
- Setting a fixed amount of gains or tax to realise based on what an investor is comfortable with.
- Using up any available basic rate tax bands for CGT, mindful of dividends and interest and other income or gains.
- Aiming to wash out gains over a fixed number of years.
- Funding ISAs each year from a taxable portfolio (if not from cash), irrespective of gains, to make good use of the ISA allowances and improve the overall tax-efficiency of the portfolio.
- Simply accepting any CGT in the routine management of the portfolio (e.g. in maintaining the risk profile of the holdings).
- Deferring gains indefinitely, with capital gains being rebased on death.
Losses
CGT is charged on your total gains each tax year, but losses can be deducted from the gain in working out how much tax is owed. It is not possible to carry forward any unused exemption, but it is possible to carry forward any losses that haven’t been used to offset gains. Capital losses can be recorded via self-assessment (SA108) or by writing to HMRC (write to HMRC), and must be done so within 4 years of the loss.
It is worth noting that the exemption and losses in the tax year of the realisation of the gain must first be used, in that order, before any previous losses can be carried forward.
Gov.uk has a guide to offsetting losses against gains here.
Tax & Legislation Diversification
Holding funds in other investment vehicles provides some diversification when considering potential future changes in tax rates and legislation (e.g. when considering capital gains tax, the taxation of dividends and the associated allowances and exemptions). These investment vehicles also typically mean that any investment income and gains are not reportable, saving time and possibly cost (e.g. accountant’s fees).
Otherwise, these reduced limits emphasise the importance of using tax-efficient investment strategies, with some key considerations below. Please note a full discussion of these points is beyond the scope of this article.
- ISAs – ISAs allow you to invest in cash, stocks and various types of fund. They grow free of income tax and capital gains tax, therefore improving the net return to investors when compared to a taxable portfolio. Withdrawals are also completely tax free.
- Pensions – Investments within a pension grow free of income tax and capital gains tax. Up to 25% of a pension fund can generally be drawn tax-free, subject to certain limits.
- Tax relief is also usually available on pension contributions. This means that a contribution generally costs less, allowing for the tax saving. Therefore, more is invested in the pension from outset.
- Using a pension for income in retirement is often beneficial as higher or additional rate taxpayers can get larger amounts on their contributions, but when it comes to drawing benefits they may only pay basic rate income tax (provided their income from their pension and other sources remains within the basic rate band).
- Pensions do not generally form part of one’s estate, meaning they should also benefit from being free of inheritance tax (IHT).
- Offshore Investment Bonds – The income and gains within an offshore bond fund will normally be free of tax in the relevant jurisdiction. This can mean that the investment growth within the offshore bond can accumulate faster than may otherwise be the case for taxable investments.
- Up to 5% of the original investment can be withdrawn every year without incurring an immediate income tax liability. This accumulates if not used. This may offer a tax efficient method of withdrawing money from a bond.
- Top slicing relief can potentially help reduce tax on the bond gains on final surrender by generally spreading this across the number of years the bond has been held.
Reporting to HMRC
Due to the reduced allowances, many of those who will not have previously had to worry about reporting their gains, interest or dividends will be dragged into doing so. This can be done via a full tax return or in some cases via the Government Gateway. For more information on when reporting is required and how to do so, visit the links below:
In Conclusion
Deciding the best course of action ultimately depends greatly on each investor’s personal and financial circumstances and objectives. A financial adviser will be able to go through the strengths and drawbacks of each method, or combination of methods, in a way that is bespoke and personal.
Risk Warnings
This article is distributed for educational purposes for UK residents. It should not be considered investment or tax advice, an offer of any security for sale nor a recommendation of any particular security, strategy, platform or investment product. This article contains the opinions of the author but not necessarily the Firm. Information contained herein has been obtained from sources believed to be reliable but is not guaranteed. It is based on our current understanding of tax legislation which is subject to change in the future.
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