Tax planning may pay dividends for investors

The Chancellor, Rachel Reeves, asked ‘everyone to make a contribution’ when presenting her package of new income tax measures at the UK Budget on 26 November. Here, we review the changes to the UK income tax regime and set out some of the potential planning options to consider taking, to help manage the impact and maximise your wealth.

The main income tax changes announced can be summarised as follows:

• Income tax thresholds will be frozen for a further three years until at least 6 April 2031.
• Dividend tax rates will increase by 2% to 10.75% for basic rate taxpayers and 35.75% for higher rate taxpayers with effect from 6 April 2026. The additional rate will remain unchanged at 39.35%.
• Savings (e.g. interest) tax rates will increase by 2% to 22% for basic rate taxpayers, 42% for higher rate taxpayers and 47% for additional rate taxpayers from 6 April 2027.
• New income tax rates will also come into effect for English taxpayers from 6 April 2027 (basic rate – 22%; higher – 42%; property additional rate – 47%). [What are the UK tax considerations? | Anderson Strathern]

Scottish taxpayers are subject to income tax at the UK rates on dividend and savings income. Scottish income tax rates will, however, apply to the earnings of Scottish taxpayers from employment, self-employment, pension income and income from property.

What is the tax treatment of dividends?

The dividend allowance of £500 is effectively a 0% rate band for dividend income and reduces the taxpayer’s available basic rate or higher rate bands. Dividends in excess of the tax-free allowance are subject to dividend tax rates based upon whether they fall into the taxpayer’s basic rate, higher rate or additional higher rate bands, with the rates currently  being 8.75%, 33.75% and 39.35% respectively.

What is the impact for you?

The UK Government’s stated purpose behind the increases in dividend and savings tax rates is to ensure income generated from assets is taxed more fairly. This measure may be designed to deter taxpayers incorporating their businesses purely for tax purposes by increasing the effective tax rates for extracting company profits by way of dividends. It should come as no surprise, however, that the impact of these measures will extend well beyond this target.

Taxpayers who rely on their personal investment portfolios and savings to provide them with a regular annual income stream will be facing increased tax liabilities when the new tax rates come into force. All basic rate taxpayers with annual dividend income in excess of the dividend allowance of £500 will be worse-off from 6 April 2026.

What can be done to minimise the impact?

The effective tax rate of dividends will continue to make dividends more attractive than receiving salary, bonuses, or pension income. There may, however, still be options available to help minimise the impact of the changes depending upon your circumstances:

Dividend policy and timing of payment

Family companies can determine the timing and amount of dividends paid.

It may be more commercially viable and tax-efficient for profits to be retained in the family company for a longer period of time. The aim would be to defer and potentially reduce the dividend tax liability by spreading dividends over a number of tax years or paying dividends in a year when the rate of tax payable by the recipient will be less.

In certain circumstances company owners may consider retaining profits in the company until it is wound-up in order for the ultimate distribution to benefit from potentially lower CGT rates.

Transfer of shares to other family members

Shares in the family company or in an investment portfolio could be transferred to your spouse or civil partner, other family members and/or a family trust. This could enable dividends to potentially be taxed at lower rates. There is currently no CGT charge on the transfer of shares between spouses or civil partners. A capital gain arising on the transfer of shares to other family members will potentially be subject to CGT at up to 24%. There are, however, CGT reliefs potentially available for the transfer of shares in unquoted trading companies or into trust.

This type of planning requires a great deal of care when the shares being transferred are in a family company. Any dividends paid to other family members require to be justifiable and genuine in practice in order not to be caught by any tax avoidance rules. This will not be an issue for shares being transferred from a personal investment portfolio. Be aware also that income arising following the transfer of investments from a parent to a child will remain taxable on the parent until the child reaches age 18.

Investments

There are a number of potential investment options available, which either favour capital growth with a lower income yield, shelter dividend income tax-free or offer tax incentives for saving over longer terms. For example:

• ISAs provide a tax-free environment for capital growth and income.
• Pension contributions can be highly tax-efficient.
• Investment in the Enterprise Investment Scheme or through a Venture Capital Trust may qualify for income tax relief.
• Capital investment bonds enable you to make annual 5% tax-free withdrawals of your original capital while deferring any income tax on the capital growth within the bond until a future date.
• Investment in commercial woodlands can provide income tax-free returns.
• Investment in a family business may attract several forms of tax benefits.

This demonstrates that minimising your income tax exposure does not need to be complicated. It can simply involve pro-active asset structuring and cash-flow management.

How we can help

We would strongly recommend that you establish the tax, legal and financial implications, and seek specialist tax and financial advice tailored to your own circumstances before taking any action. Please contact martin.campbell@andersonstrathern.co.uk if you need support with this.