10% ISA dividend tax

Jobber200

Hello,

I have a stocks and shares ISA. I understand that although it's a tax efficient wrapper, dividends are taxed at 10% (not reclaimable since 2004) whilst interest from bonds are not.

For non-taxpayers (i.e. income less than the Personal Allowance during financial year or non UK resident), is there a case for using an investment platform outside the UK to make investments which is more tax efficient ? Will I still have to contact HMRC to pay a 10% tax on dividends received outside the UK ?

For example, HSBC Hong Kong have a comprehensive online investment platform that let's customers buy OEICs / Unit Trusts yet there is no dividend tax deducted at source there.

Thanks-

Your_Hero

Technically there is actually no tax paid at all.

It is a notional tax credit meaning the dividends you received gets grossed up by that missing 10%. I.e. if you receive £90 dividend, the gross dividend is £100.

As there is no real tax paid, you can't reclaim it no matter what vehicle or platform you use.

For example, HSBC Hong Kong have a comprehensive online investment platform that let's customers buy OEICs / Unit Trusts yet there is no dividend tax deducted at source there.

To my understanding, as a UK resident, you have to declare this earning through your annual tax returns and it will be added to your income for the year.

bowlhead99

If you take a UK company you want to invest into, say Tesco. It makes sales, pays costs and is left with profits. It pays tax on those profits. It has a stash of cash left over. Let's say this works out to 20p a share. It decides to reinvest most of it in its business and distribute 9p a share to its investors.

It writes cheques at 9p a share to all its investors. Some of those are ISAs or pensions, some of them are direct individual shareholders.

Those customers (ISA or not) all receive 9p. The UK government recognises that actually, looking back to how much profit was originally made, Tesco already paid a bunch of tax before they gave it to you the owner of Tesco. So they are willing to 'help you out' with your tax bill, if you have one.

The amount of tax Tesco actually paid might be 1p or 2p or 3p a share or even more. But basically the UK government, due to a quirk of how the tax system used to work, acknowledge a notional tax credit of 1/9th of the dividend that tesco pays out in cash. So if you get 9p, they say that notionally you got 10p and 'paid' a penny of tax.

- If you are a lower rate taxpayer you only need to pay tax at 10% on the 10p dividend which is covered by your 1p tax credit, so you keep the 9p for yourself, which is all that Tesco sent out to their shareholders.

- If you are a nil rate taxpayer or an ISA or pension investor, you do not pay any taxes. So you keep the 9p for yourself, which is all that Tesco sent out to their shareholders.

- If you are a higher rate taxpayer and not using an ISA or pension, you will need to pay a bit more tax as the 1p isn't enough to settle your responsibility.

However, what is happening is that you are either paying tax (as a high rate taxpayer) or not paying anything whatsoever out of the 9p that Tesco sent you (as a low rate taxpayer or nil rate taxpayer or ISA or pension holder). Meanwhile Tesco is sending out 9p to all its owners, regardless of status, and is not sending anything to the government on your behalf. It is merely paying its ongoing corporation tax based on its profits, as and when it needs to.

Due to the quirk of legislation, the 1p notional tax credit reduces our tax bills on any income that comes with this credit, but the 1p isn't actually income tax that we suffered. So an ISA holder can't go to the government and say 'hey I am not a tax payer so I want my 1p'. You received every penny of the 9p that Tesco wrote a cheque for. The OEICs also received their 9p a share, whether you are buying them here or offshore. You can't magically get 10p, by any route, because Tesco are only writing cheques for 9p.

You are right, it is different with bond interest. There is no dodgy notional tax credit for bond interest. If Tesco pay interest on a bond, it is an expense to them and the profits go down and there is less left over at the end of the year. Which makes their tax bill go down. And therefore when you receive the income, the government wants to tax you. You escape the tax if you hide in an ISA, your ISA provider claims it back so you get the full amount the company sent out. If you were not using an ISA and not a nil taxpayer, you would have suffered the tax.

So from this you can see that ISAs are relatively more effective for holding bonds (because they allow you to receive untaxed bond income) than they are for holding shares (because you receive dividends in an ISA without paying any real tax, but if you had been holding outside an ISA you might not have paid any real tax anyway, due to the existence of the nice friendly notional tax credit).

Of course on a side note, ISAs are still useful for shares because shares can deliver a lot of growth ; it's quite handy to have the comfort that by using an ISA you will never pay any CGT or dividend tax ever, even if you end up making monster gains or become a high rate taxpayer, and you don't need to keep any records. Some people don't need the dividend tax protection because they were covered by the notional tax credits. But you can't get your hands on those tax credits in cash, by any method.

Jobber200

Your_Hero wrote: »

It is a notional tax credit meaning the dividends you received gets grossed up by that missing 10%. I.e. if you receive £90 dividend, the gross dividend is £100.

Semantics aside, on a practical level I found this from the HMRC website:

***
Can you claim the tax credit if you don't normally pay tax?

No. You can't claim the 10% tax credit, even if your taxable income is less than your Personal Allowance and you don't pay tax. This is because Income Tax hasn't been deducted from the dividend paid to you - you have simply been given a 10% credit against any Income Tax due.
***

Therefore (as I understand), a non taxpayer would "pay" a 10% Tax Credit which isn't offset by the 10% Tax which would've been paid as a Basic Rate tax payer.

This 10% credit is deducted at source by UK based investment platforms and can't be reclaimed. Perhaps the question below is what I'm trying to ask:

Overseas investment platforms do not make this deduction at source. If the income is declared to HMRC will they ask me to pay the 10% tax credit at the end of the tax year ? (since as you mentioned it's not actually a tax)

Jobber200

bowlhead99 wrote: »

If you take a UK company you want to invest into, say Tesco. It makes sales, pays costs and is left with profits. It pays tax on those profits. It has a stash of cash left over. Let's say this works out to 20p a share. It decides to reinvest most of it in its business and distribute 9p a share to its investors.

It writes cheques at 9p a share to all its investors. Some of those are ISAs or pensions, some of them are direct individual shareholders.

Those customers (ISA or not) all receive 9p. The UK government recognises that actually, looking back to how much profit was originally made, Tesco already paid a bunch of tax before they gave it to you the owner of Tesco. So they are willing to 'help you out' with your tax bill, if you have one.

The amount of tax Tesco actually paid might be 1p or 2p or 3p a share or even more. But basically the UK government, due to a quirk of how the tax system used to work, acknowledge a notional tax credit of 1/9th of the dividend that tesco pays out in cash. So if you get 9p, they say that notionally you got 10p and 'paid' a penny of tax.

- If you are a lower rate taxpayer you only need to pay tax at 10% on the 10p dividend which is covered by your 1p tax credit, so you keep the 9p for yourself, which is all that Tesco sent out to their shareholders.

- If you are a nil rate taxpayer or an ISA or pension investor, you do not pay any taxes. So you keep the 9p for yourself, which is all that Tesco sent out to their shareholders.

- If you are a higher rate taxpayer and not using an ISA or pension, you will need to pay a bit more tax as the 1p isn't enough to settle your responsibility.

However, what is happening is that you are either paying tax (as a high rate taxpayer) or not paying anything whatsoever out of the 9p that Tesco sent you (as a low rate taxpayer or nil rate taxpayer or ISA or pension holder). Meanwhile Tesco is sending out 9p to all its owners, regardless of status, and is not sending anything to the government on your behalf. It is merely paying its ongoing corporation tax based on its profits, as and when it needs to.

Due to the quirk of legislation, the 1p notional tax credit reduces our tax bills on any income that comes with this credit, but the 1p isn't actually income tax that we suffered. So an ISA holder can't go to the government and say 'hey I am not a tax payer so I want my 1p'. You received every penny of the 9p that Tesco wrote a cheque for. The OEICs also received their 9p a share, whether you are buying them here or offshore. You can't magically get 10p, by any route, because Tesco are only writing cheques for 9p.

You are right, it is different with bond interest. There is no dodgy notional tax credit for bond interest. If Tesco pay interest on a bond, it is an expense to them and the profits go down and there is less left over at the end of the year. Which makes their tax bill go down. And therefore when you receive the income, the government wants to tax you. You escape the tax if you hide in an ISA, your ISA provider claims it back so you get the full amount the company sent out. If you were not using an ISA and not a nil taxpayer, you would have suffered the tax.

So from this you can see that ISAs are relatively more effective for holding bonds (because they allow you to receive untaxed bond income) than they are for holding shares (because you receive dividends in an ISA without paying any real tax, but if you had been holding outside an ISA you might not have paid any real tax anyway, due to the existence of the nice friendly notional tax credit).

Of course on a side note, ISAs are still useful for shares because shares can deliver a lot of growth ; it's quite handy to have the comfort that by using an ISA you will never pay any CGT or dividend tax ever, even if you end up making monster gains or become a high rate taxpayer, and you don't need to keep any records. Some people don't need the dividend tax protection because they were covered by the notional tax credits. But you can't get your hands on those tax credits in cash, by any method.

Thanks for the comprehensive reply (you can ignore my previous post, I only read yours now!). It makes much more sense now.