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Capital gains and dividend income: Tax-year end heralds reduction in annual allowances
The end of the tax year on 5 April is a date etched into many people’s minds. With annual tax allowances reset the following day, this hard deadline presents a ‘use it or lose it’ scenario.
In 2023, further urgency has been added to the tax-year end given that a number of previously announced changes to the system will be coming into effect from 6 April.
In this article, we look at some of those changes, highlighting what they could mean for your wealth and what actions you might be able to take to mitigate their impact.
Capital gains tax
Under the current system (2022/2023), you can make annual profits of £12,300 on the sale of assets before you are liable for capital gains tax (CGT). That allowance – the Annual Exempt Amount (AEA) – will reduce to £6,000 per year in the forthcoming 2023/2024 tax year, before dropping again to £3,000 from April 2024.
If your capital gains exceed the allowance, the rate at which you are taxed depends on your income-tax band. For basic-rate taxpayers, a rate of 10% generally applies. For higher-rate taxpayers, the rate is 20%.
CGT is not applicable in the context of profits from the sale of your main residence. Typically, however, it does apply in the case of second homes and other property (in the absence of private residence relief), where, broadly speaking, it is applied at 18% for basic-rate taxpayers and 28% for higher-rate taxpayers.
Full details of rates, allowances and what you pay CGT on are available from the Government website.
In a parallel with the changes to CGT, the annual tax-free allowance for dividend income is also subject to a phased reduction over the coming years.
The current rate of £2,000 will fall to £1,000 from 6 April 2023, and will be halved again to £500 for the 2024/2025 tax year.
Where dividend income exceeds the annual allowance, the rate of tax you pay is again aligned to your income-tax band. For basic-rate taxpayers, this is set at 8.75%; for higher-rate taxpayers it is set at 33.75%; and for additional-rate taxpayers it is set at 39.35%.
The impact of inflation
Taken in isolation, the fact that the allowance thresholds are being reduced for CGT and dividend tax mean they are likely to apply to more people in the future. At the same time, a combination of frozen income-tax bands and wage inflation is expected to push more people into higher tax brackets, resulting in higher payments for CGT and dividend tax.
In the case of CGT, the situation is compounded by the effect of persistent high inflation, which has pushed many assets up in value and, in turn, increased the risk of the allowance threshold being breached.
Even before the impact of the new changes are felt, evidence of this trend can be seen. According to the latest government data, £14.3 billion was paid in CGT by 323,000 taxpayers in the 2020/2021 tax year. This reflected a 19% year-on-year rise in total gains and a 20% year-on-year rise in the number of taxpayers.
Individual taxpayers have little control over the rate of inflation, income-tax banding or allowance rule changes, but there are ways that an individual can potentially minimise their burden.
Holding investments within the wrapper of a stocks and shares Individual Savings Account (ISA) can provide benefits, for example. ISAs are free from dividend tax or CGT, so investing the yearly maximum of £20,000 ensures you are making the most of this tax-efficient strategy. If you are in a situation where this ceiling is likely to be exceeded, then it might be worth considering prioritising investments that generate higher dividends within an ISA.
A longer-term proposition would be to put more investment emphasis on your pension. Not only do contributions benefit from tax-relief, but any dividends returned to a pension fund are also tax free.
There are also potential advantages that can be realised if you are in a couple. This opens the door to the possibility of transferring the ownership of assets to a partner in the lower income-tax band, while also looking at your allowances for dividend income and capital gains as a combined total rather on an individual basis.
In summary, it is understandable that the forthcoming changes to CGT and dividend allowances might lead to thoughts of taking action before the tax-year end. It is, however, always wise to proceed with caution, ensuring important decisions are made from an enlightened and informed position rather than in the shadow of a looming deadline.
The information contained within this communication does not constitute financial advice and is provided for general information purposes only. No warranty, whether express or implied is given in relation to such information. Vintage Wealth Management or any of its associated representatives shall not be liable for any technical, editorial, typographical or other errors or omissions within the content of this communication.
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