Capital Gains Tax and Dividend Taxes are important to understand as they can eat away at your returns. Capital Gains Tax refers to the tax applied to when you make a profit on your investment. Dividend Tax refers to the tax on the regular income received on an investment.
Firstly, it’s important to note that if you hold your investments in a tax-efficient wrapper such as a Stocks & Shares ISA or SIPP – you will not be subject to these taxes. Traders who conduct Spread Betting are also not subject to Capital Gains Tax.
However, if you hold your investments in a regular dealing account or perhaps need to go beyond the £20,000 Stocks & Shares ISA limit, then Capital Gains Tax and Dividend Tax should be understood.
Capital gains tax: when you profit, you can be subject to tax on the gain
When you come to sell your shares or investment – hopefully you are in line for a profit! Currently, you can make £12,300 in profit before having to pay Capital Gains Tax. Once you exceed the £12,300, then you will be subject to tax rates depending on if you are a basic or higher-rate taxpayer. If you are the former, there is a 10% capital gains tax, if you are the latter – it’s a 20% tax on capital gains.
Dividends tax: when you receive an income from dividends, you can be subject to tax on the income
You currently have a dividend allowance of £2,000 per year – you won’t be subject to tax on dividends if your income is within this amount. In the scenario that you have no other income at all – then you can also add in the general personal tax-free allowance of £12,500. This would mean you could earn £14,500 per year from dividends IF it was the only source of income for you.
Now, let’s say you have other income. The amount of tax you pay on your dividends (or income from funds including bond funds) will be taxed depending on your tax band (beyond the £2,000 per year). Basic-rate taxpayers are subject to 7.5% Dividend Tax, Higher-rate subject to 32.5% and Additional-rate 38.1%.
Arguably both the Capital Gains Tax & Dividends Tax will take relatively large-investments to be triggered – but as you build your portfolio, hopefully you will get there! This is why it’s important to use your Stocks & Shares ISA allowance – year-on-year, leaving you to generate capital gains and income free of tax.