Dividend tax squeeze to hit record 3.7 million people – how to protect your investments

The number of people paying dividend tax is expected to have risen to a record 3.7 million people in the 2024/25 tax year, as reduced allowances drag millions of new taxpayers into the tax’s scope.

Dividend tax is a tax you pay on your investments. Unlike capital gains tax, which is paid on investments that are sold at a profit, dividend tax is paid on the dividends that your investments pay.

For basic rate taxpayers, dividends are taxed at 8.75%. For higher rate taxpayers it is 33.75%. Additional rate taxpayers pay 39.35%.

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In years gone by, dividend tax only applied to dividends earned over £5,000. This was lowered to £2,000 in 2017/18. The tax-free dividend allowance was then further reduced to £1,000 in 2023, then halved again to £500 in April 2024.

The number of dividend taxpayers rose from 1.9 million in 2022/23 to an estimated 3.08 million in 2023/24, according to HMRC figures obtained by Quilter via a Freedom of Information request. This figure is expected to rise further to 3.67 million in the 2024/25 tax year.

It is estimated that 865,000 extra people became eligible for dividend tax in 2023/24, with a further 480,000 in 2024/25, as a result of the allowance cut to £500. That totals 1.25 million additional taxpayers across the two years.

^{Source: Quilter}

“These figures show just how quietly but effectively the tax net is expanding,” says Rachael Griffin, tax and financial planning expert at Quilter. “What was once a niche tax, affecting a relatively small group of higher earners and business owners, it is now impacting millions of everyday investors.”

Many of these are basic rate taxpayers, with 1.1 million basic rate payers expected to owe dividend tax in 2024/25. Many of these will be doing so for the first time.

“This will have come as a surprise,” says Griffin, “especially if they hold only modest investments outside ISAs or pensions.”

How much revenue does the government make from dividend tax?

Millions of investors have been hit by frozen tax thresholds, often known as stealth taxes, as they’ve been dragged into higher tax bands as incomes have risen. The reduction of dividend tax thresholds is a similar phenomenon.

Quilter’s data shows that the April 2024 cut was forecast to raise £450 million in 2024/25, rising to £810 million in 2025/26, £860 million in 2026/27, and £940 million in 2027/28, according to HMRC’s latest projections.

“The Government has made clear that it expects to raise hundreds of millions in additional revenue from these changes, and the figures show it is well on track to do so,” said Griffin. “But the cost isn’t just financial, the complexity of compliance is growing, particularly for those unfamiliar with the tax system.”

Could the dividend tax allowance be scrapped?

More misery could be on the way for investors. A memo to the Treasury from deputy prime minister Angela Rayner that was leaked in March recommended scrapping the dividend tax allowance altogether, as well as increasing the level of dividend tax paid by the wealthiest investors.

However, it is thought that, when the Autumn Budget comes around, the dividend tax allowance won’t be impacted.

“Given how attractive the UK market is for investors seeking dividends, it would be counterintuitive to make dividend investing less rewarding given that the government is keen to encourage investment in the UK,” said Sarah Coles, head of personal finance at Hargreaves Lansdown.

How to protect your investments from dividend tax

There are ways to ensure that your investments are exempt from paying dividend tax, with the most important being making use of tax-efficient wrappers such as ISAs.

“Making full use of ISAs, pensions and other tax-efficient wrappers has never been more important,” says Griffin.

Any investments held in a stocks and shares ISA are exempt from taxes on dividends or capital gains, so ensure you make full use of your annual £20,000 ISA allowance.

The same is also true of investments held in your pension. Dividends can accumulate here or in a SIPP without eating into your dividend allowance.

Venture Capital Trusts (VCTs) are also exempt from dividend tax, though these are typically high-risk investments. They have the added advantage, though, of offering 30% up-front tax relief.