Dividends, or the income from funds and shares, are an important part of returns paid to stock market investors, to compensate for the risks we take with our money. Now City and Westminster speculation suggests that the government plans to impose a stealthy new tax on those returns, by deducting national insurance contributions from dividends.
This could cut investors’ income by 15 per cent, in addition to other deductions from income and gains, if the new tax is imposed at the same level as employees’ class 1 national insurance contributions. It is cold comfort for small shareholders to know that while our returns might be reduced, we will certainly get to keep all the risk of capital destruction when fund and share prices fall. As City cynics say, success has many fathers but failure is a bastard.
Unlike capital gains tax, it is difficult to see how national insurance deducted from dividends paid by profitable funds and shares could be offset by taking account of investments that suffered losses. The new stealth tax also looks set to be another form of double taxation, because dividends are paid by companies after they have paid corporation taxes of between 19 per cent and 25 per cent.
We won’t know for sure until November 26, when Rachel Reeves presents her second budget. Sad to say, the budget she delivered last year does not augur well for anyone hoping that their worst fears might prove misplaced.
Reeves promised before Labour was elected not to raise taxes but promptly did so as soon as the “rogue landlady” got into No 11 Downing Street. She blamed previous Conservative governments, who had also promised not to raise taxes before they did so.
As I have pointed out here before, all politicians believe they need our money more than we do. Reeves talks about encouraging economic growth and raising the risk capital to fund that through stock market investment but all her actions so far have had the opposite effect.
She increased the jobs tax, more formally known as employers’ national insurance contributions, from 13.8 per cent to 15 per cent, which took effect in April, and nearly halved the minimum pay on which it is imposed from £9,100 to £5,000 a year. That meant pubs and restaurants paying people to do a few nights a week behind the bar or serving supper must pay the new, higher rate of employers’ national insurance.
• Imogen Tew: The fat jab effect: there’s money to be made in biotech
More tax on jobs means fewer jobs. There’s no need to take my word for this. The Department for Work and Pensions admitted last week that one million more people are claiming out-of-work benefits, without the requirement to look for a job, than there were a year ago. The number of universal credit claimants now exceeds seven million.
Reeves talks about “growth, growth, growth” but the only thing that is definitely growing is the dole queue. Well, that’s not quite true, because something similar is happening at the exits from the London Stock Exchange.
To beat tax rises repeatedly hinted at by Reeves, shareholders are queueing up to bale out of the London Stock Exchange, which remains one of Britain’s few world-class institutions, largely because London is roughly halfway between Tokyo and New York. This makes it a good place to keep global trading going 24 hours a day, also helped by the fact that more Americans and Japanese speak some kind of English than any form of French, German or Italian.
There’s not much even Reeves can do to damage those geographic and linguistic advantages. But stamp duty on shares bought in Britain extracted £3.2 billion from investors trading on the London Stock Exchange last year, which they would not have had to pay if the deals had been done in America, Germany or Japan.
Along with the threat of new dividend taxes, that prompted a record £7.3 billion to be withdrawn from British funds and shares during the four months to the end of October, according to Calastone, an international investments network.
• Six-figure earners to lose £50,000 under Rachel Reeves’s salary sacrifice raid
It’s all bad news for anyone, like me, who is relying on a defined contribution pension to pay for retirement. It’s also bad news for all those evil people working in the Square Mile (boo-hiss!) who are paying rising amounts of tax.
Fortunately Reeves and all our politicians don’t have to worry about this because — like most people employed in the public sector — they can rely on old-fashioned, risk-free, inflation-linked, defined benefit or final-salary pensions, subsidised by the good old taxpayer.
But regular readers will know that, in addition to describing financial problems, I try to find solutions. So the one chink of light that might keep hope alive amid the gathering gloom is that it would be difficult to impose national insurance on dividends paid into Isa and pension funds.
Income from stock market funds and shares retained within these tax shelters is completely beyond the grasp of HM Revenue & Customs. Withdrawals from pensions above the 25 per cent tax-free lump sum allowance are subject to income tax in the usual way but withdrawals from Isas are tax-free.
Depending on how the putative stealth tax is imposed, it might still be possible to defer payment or even avoid dividend tax. There could be some wishful thinking here, because in recent years I have deliberately bought some high-yielders to diversify away from artificial intelligence funds and shares, such as Polar Capital Technology (stock market ticker: PCT) and Microsoft (MSFT), which pay no dividends but aim for capital growth instead.
By contrast, for tax-free income, I hold the £299 million London-listed ship-leasing investment trust Tufton Assets (SHPP) in my Isa. It pays 8.3 per cent dividend income, which it increased by an annual average of 7.4 per cent over the last five years. However, its high-risk, cyclical sector and soggy share price performance mean Tufton is priced 18 per cent below its net asset value (NAV).
Similarly, the self-descriptive investment trust Greencoat UK Wind yields just over 10 per cent tax-free in my Isa from a £2.2 billion portfolio of wind farms. Independent statisticians at Morningstar calculate that Greencoat raised dividends by an annual average of 7.6 per cent over the past five years. Battered by adverse factors including low wind speeds, rising costs and folk who hate wind farms, the shares are priced at an eye-stretching 29 per cent discount to NAV.
So both investment trusts might prove to be bargains for the brave and are paying us to be patient. If they can sustain their rate of rising dividend distributions, they would double shareholders’ income in less than a decade. That’s much less time than I hope to spend in retirement, Deo volente.
However, it is important to beware that dividends are not guaranteed and can be cut or cancelled without notice. In that sense, they might not be worth any more than politicians’ promises.
