The new dividend tax: a simple case of double taxation

A “tax allowance”. That’s what the Government calls the new £5,000 tax-free band of dividend income announced in the Budget.

In other words, it’s a favour they are doing us – offering a tax perk, akin to the breaks on Isas or the tax-free personal allowance.

By introducing a dividend tax but exempting the first £5,000, the implication is that the Chancellor is closing a loophole in the tax system but sweetening the pill a little for those investors who make less than this sum every year from their shares.

In reality, I think it’s more a case of introducing double taxation on dividends.

The recent history of dividend taxation is convoluted and incomprehensible even by the standards of Britain’s labyrinthine tax code.

But broadly speaking, dividends were exempted from an explicit tax during changes to the regime in 1997 and 1999 (when Gordon Brown respectively stopped pension funds from reclaiming a dividend tax credit and then abolished “advance corporation tax”) because it was accepted that the money handed to shareholders as dividends had already been taxed when the company concerned paid its corporation tax bill.

• Budget 2015: Dash for dividends ahead of £7bn tax raid

This arcane story is no doubt long forgotten by most taxpayers, but the essential point hasn’t changed. “You can’t pay a dividend as a company unless you have already paid tax on your ‘distributable reserves’,” Nigel Neville of Baker Tilly, the accountancy firm, confirmed this weekend.

Although not all tax experts agree, there are many who maintain that levying a tax on dividend recipients does indeed amount to double taxation.

Some argue that a company and its shareholders are separate legal entities and that each should pay tax. But what is a company? It’s a device for producing a return on investors’ capital. When that return is produced of course it should be taxed, but doing so both within and outside the company seems to me to be a simple case of taxing the same money twice.

So, far from bringing dividends into line with other income, the new levy seems just the latest in a long line of stealth taxes aimed at a group of people unlikely to inspire much sympathy.

If you have significant shareholdings outside Isas, it may be worth starting to transfer them. Doing so will involve selling and buying back the shares, of course, which could trigger a capital gains tax bill. But there is an annual CGT allowance of £11,000, so you could sell just enough shares to make this gain, repurchase the shares in an Isa, and do the same next year.

Beyond this allowance, you could sell and buy back in a pension – the tax uplift you get could well exceed the CGT bill.

We’ll be looking at other ways to minimise the effects of the new tax in more detail in the weeks ahead. Let me know your thoughts via the email address below.