Dividend tax hike in the UK: What you need to know

UK investors will have to pay more on their incoming cash flow from their dividend paying stocks as the UK Government announced on September 7 a 1.25% hike in dividend tax. The plan came alongside with a similar 1.25% bump in National Insurance rate and a state pension increase for retirees for the 2022-23 tax year.

Who is subjected to the new dividend tax increase in the UK?

• Anyone holding investments outside of a stocks and shares Isa (type of savings account where you don't have to pay on any dividends, interests, or capital your investment makes)
• Investors who have exceeded their dividend tax allowance and people who run their own businesses and pay themselves dividends

The tax increases in 2021 is one of the biggest since 1990 if we combine this year's corporation tax increase with the recent health and social care levy. They would have a total average annual cost of policy of £26bn over three years, topping the VAT increase to 20% in 2010, which had an average of £18bn.

The announcement will also push UK's tax burden, or in other terms Tax-to-GDP% to roughly 35%, which is the highest level since 1969/1970.

Why did the government increase tax on dividends?

The coronavirus has stretched the NHS and social care to their limits and which required a lot of financing to turn things around. The dividend tax will help fund a £12bn-a-year plan (3 years for £36bn) to help clear NHS waiting list backlogs and fund social care.

The government tried to tackle their social care crisis five years ago through allowing eligible councils to hike hiking council tax bills by around 3%, more than the capped increase to help fund social care. However, it was not enough to eradicate the crisis.  

In addition, waiting lists for routine NHS care have swollen to levels last seen 15 years ago because of the pandemic. It estimated that NHS waiting list backlogs is at 5.6 million people and could potentially reach 13 million without immediate action.

Bad news ripple through the market

Investors did not take the news lightly and you can't blame them. They already witnessed substantial dividend cuts by many of their holdings last year due to the pandemic, where an estimated 12.2% decline in global dividend pay-outs was registered, especially in second and fourth quarters of 2020 (Global Dividend Index, Janus Henderson).

Dividend cuts were most severe in the U.K. and Europe, the index found, with both combined accounting for more than 50% of the total reduction in pay-outs globally. This trend was noteworthy there because of the forced reduction of banking dividends by regulators to support lending to households and businesses.

The recent news sent the FTSE 100 to red territory for three straight days dropping from GBX 7,187.18 on September 7 opening session to sink just below the GBX 7,000 mark during September 9 trading session. The footsie ended the week at GBX 7,029.20, down 1.7% since PM Boris Johnson's tax hike announcement.

ETFs tracking the FTSE 100 or invest in large cap UK stocks followed suit with declines of their own with iShares Core FTSE 100 UCITS ETF (ISF) and iShares MSCI United Kingdom ETF (EWU) losing almost 2.0% during the same three-day drought (in their respective currency terms).

How much dividend tax will investors pay?

Dividend taxes are usually paid on income investors get from investing in shares or in funds that invest in shares on their behalf. For the 2021-2022, no taxes on dividends are necessary for the first £2,000, under the tax-free dividend allowance.

Above that threshold, investors will pay tax based on the rate they pay on their other income, also known as the tax band. The figures below show exactly how much the taxman was getting this year on dividends and how much is expecting next year:

• Basic rate is 7.5% for 2021-2022 and will become 8.75% in 2022-23
• The higher rate is 32.5% for 2021-2022 and will become 33.75% in 2022-23
• While the additional rate will grow from 38.1% for 2021-2022 to 39.35% in 2022-2023

For people whose only income are dividends, they can use their tax-free personal allowance before they start paying tax on dividends. So other than the £2,000 dividend allowance, they could earn another £12,570 tax-free in 2021-22.

Long-term market repercussion

It’s still hard to see whether the tax hikes would negatively affect the market in the long-term. There have been different tax policies implemented worldwide and one can say that not all taxes are created equal, as higher, or lower tax rates can be double-edged swords. It's all about the end goal, the timing and implementation under a strong leadership.

For now, local investors must take the hit and hope for the betterment of their healthcare system, after all, what's money without health?

Foreign investors who own two-thirds of UK market will not be liable for tax increase. Yet, it doesn't mean they won't be hesitant to call it quits, since historically, investors look for markets where overall tax are less punitive.

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