Dividend allowance 2023/24: investor implications

As of 6th April 2023, the annual tax-free dividend allowance in the UK was halved to £1,000. This is the second time the allowance has been reduced since 2017/18 (at which point it stood at £5,000), and the figure is set to be halved once more in April 2024.

Representing a 90% reduction of the allowance over a 6-year timespan, this is one of the most significant decreases of any UK tax during that period.

For investors, business owners and directors that receive regular dividends, this change could prove highly erosive. Subsequently, researching its finer details - as well as alternative routes available to minimise the tax - could prove highly rewarding in the long term.

What is the dividend tax allowance for 2023/24?

The tax free dividend allowance for the 2023/24 financial year has been halved from £2,000 in 2022/23 to £1,000.

This means that any individual that receives over £1,000 in dividend income in the 2023/24 financial year will be liable to pay dividend tax on the excess at their marginal rate.

An investor's marginal rate of dividend tax correlates with the income tax band they fall into. Ranging from 0% to 39.35%, the dividend tax rates for 2023/24 have remained unchanged from 2022/23, and are as follows:

How does the 2023/24 dividend allowance compare to previous and upcoming tax years?

Introduced in 2016/17, the annual tax free dividend allowance originally stood at £5,000. In 2018/19 this was reduced to £2,000, at which level it remained for five years.

In 2023/24 the dividend allowance has been halved to £1,000, and is set to be halved again at the start of the 2024/25 tax year.

Standing at £500, this will equate to a total decrease of 90% in the allowance in the space of six years. With the current Chancellor not ruling out subsequent reductions of the allowance following the 2024/25 tax year, this could see this figure decrease further.

What does this mean for investors?

For investors, these drastic reductions make the dividend tax allowance a fraction as effective as it once was, and could have severe impacts on long term dividend gains.

For example, for an additional rate taxpayer paying the highest 39.35% rate of dividend tax, this will mean that of the first £5,000 in dividends they receive from April 2024, £1,770 more of it will be deducted in dividend tax than it would have been six years earlier.

Such considerable changes could increase the tax pressure placed on investors that rely on dividends as a central source of income, challenging the ability of asset classes such as dividend-paying stocks to generate regular considerable returns.

Ultimately this could mean options such as dividend-paying stocks could become less popular among a proportion of experienced investors. However, equity options that prioritise long term capital growth over dividend payments - as well as tax efficient investment schemes that can negate dividend tax - could prove popular alternatives.

What other tax free allowances can investors make use of in 2023/24?

The dividends tax allowance is just one of a number of tax-free allowances investors can make use of in the UK.

Ranging from the capital gains tax allowance to the ISA allowance, the following additional allowances can enable investors to maximise the potential of their tax-free investments in 2023/24.

• Capital gains tax allowance: Each tax year, UK residents are able to make gains on the sale of assets, such as stocks or property, up to a certain threshold without paying any capital gains tax (CGT). For the 2023/24 tax year, this threshold stands at £6,000, having decreased by more than 50% from the previous tax year when it was £12,300.
  
  
• ISA allowance: An individual savings account (ISA) allows UK taxpayers to save a certain level of capital each tax year without paying tax on any interest or investment returns they earn. Investment ISAs include the Stocks and Shares ISA and Innovative Finance ISA (IFISA). The annual ISA allowance for 2023/24 is £20,000, which can be allocated solely into one ISA or distributed across different types of ISAs.
  
  
• Personal allowance: Every UK resident has a personal allowance, which is the level of annual income (including salary as well as additional forms of income) they are able to earn before any income tax is due. For the 2023/24 tax year, the personal allowance is £12,570.
  
  

What tools can investors use to avoid dividend tax?

Though all UK taxpayers can make use of their annual tax-free dividend allowance, set to drop to £500 in 2024/25, this rapidly decreasing allowance is proving increasingly restrictive.

Though these changes have decreased the effectiveness of the allowance considerably, a number of tax efficient routes exist to assist with mitigating or avoiding dividends tax entirely.

1. The Enterprise Investment Scheme (EIS) and Seed Enterprise Investment Scheme (SEIS)

The Enterprise Investment Scheme (EIS) and Seed Enterprise Investment Scheme (SEIS) are tax efficient venture capital schemes, designed to encourage private investment into early stage companies via a range of generous tax advantages.

Including up to 50% income tax relief, capital gains tax exemption, capital gains deferral relief and inheritance tax exemption, the schemes' reliefs support investors in minimising the risk and maximising the potential returns associated with venture capital across.

Whilst the schemes do not strictly provide dividends tax exemption, their long term focus is centred around providing an overall return upon exit rather than regular dividend repayments.

With exits usually occurring between five and ten years from the initial investment, this longer term focus (in most cases) negates the requirement of dividends and targets considerably higher investment growth than traditional dividend-paying stocks.

Furthermore, the recent changes to the SEIS could make this option even more attractive for investors looking to maximise their tax liabilities in the 2023/24 tax year.

2. Venture Capital Trusts (VCTs)

Venture Capital Trusts (VCTs) are tax-advantaged investment schemes in the UK that are designed to encourage investment in small and growing companies.

Unlike the EIS and SEIS, VCTs are listed investment vehicles, managed by a fund manager, that facilitate investment into a collection of eligible early-stage companies (with the requirement of additional fund fees).

Similarly to the EIS and SEIS, most VCTs tend to be growth-focused investments, though some VCTs will distribute tax-free dividends.

Where this can make VCTs an effective alternative for mitigating dividend tax, their allocation of shares across a greater number of companies, less generous tax incentives and additional fund fees can inhibit their ability to generate as considerable net gains as EIS and SEIS investments.

3. Individual Savings Accounts

ISAs (Individual Savings Accounts) are tax-advantaged saving/investment accounts that can allow individuals to save and invest varying amounts each year without paying tax on the income or capital gains earned.

Investment ISAs such as the Stocks and Shares ISA can enable investors to mitigate dividend tax liabilities by providing tax-free status to dividends earned within the account.

Though this can prove an effective alternative for individuals looking to maximise the potential for tax-free dividends, ISA contributions are capped at £20,000 per year - considerably lower than the £1 million EIS and £250,000 SEIS annual investment maximums.

4. Self invested Personal pensions (SIPPs) and Small Self Administered Schemes (SSASs)

SIPPs (Self-Invested Personal Pensions) and SSASs (Small Self-Administered Schemes) are types of pension schemes in the UK that can enable individuals to invest for their retirement tax efficiently.

The primary difference between the two are that SIPPs are personal pensions set up for individuals, whereas SSASs are occupational pension schemes, usually set up by a company's directors for a group of up to 11 members.

Dividends and capital gains received within both SIPPs and SSASs will be liable to pay 0% dividend tax and capital gains tax, however the minimum required age to access both schemes' pension pots is 55.

Planning your investments with dividend tax in mind

Whilst an individual's capital allocations for 2023/24 and beyond will largely depend on personal circumstances and investment goals, planning for the current and upcoming reductions to the dividend tax allowance should play a role in every experienced investor's tax plan.

Whether this is by reducing the dividend-paying stock proportion of an investor's portfolio in favour of growth-focused alternatives such as the EIS and SEIS, or instead by making full use of the existing tax-free allowances available, ensuring appropriate action is taken to account for the 90% reduction of the dividend allowance over six years could save investors considerable sums of capital.

Regardless of personal tax plan or investment strategy, you can explore the most significant tax changes impacting investors this tax year in GCV's Investor Guide to 2023/24 Tax Changes, and explore the UK's tax efficient investment strategies in the Guide to Tax Efficient Investing.