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Do You Pay Tax On Dividends That Are Reinvested?

do you pay tax on dividends that are reinvested

Whether or not you pay tax on dividends that are reinvested is important for investors to understand as their tax implications depend on how the dividends are being reinvested.

If a company pays out cash dividends to shareholders and they use that cash to buy additional shares (in other words, they reinvest the dividends themselves – the company does not automatically reinvest the dividends on their behalf), that shareholder will owe income tax on the dividend payments made in the year they are received – just as if they were taken as cash and never reinvested.

If, however, the company reinvests the dividends by using them to purchase additional shares on a shareholders’ behalf through a dividend reinvestment plan (DRIP) (the company reinvests the shares automatically, without the shareholder having to do a thing or ever receiving the dividends physically themselves), that shareholder does not pay income tax on the reinvested dividends until they eventually sell the shares. At the point of selling the shares, capital gains tax would apply on any increase in share value since the reinvestment occurred.

In short, reinvesting dividends doesn’t make them tax free, but it can allow shareholders to defer paying income tax and instead pay the potentially lower capital gains rate when they come to sell their shares at a time that suits them.

Read on for further insight on when you should consider reinvesting or cashing out your shares in a business by giving consideration to the tax implications of each option.

What Are Dividends And How Are They Paid To Shareholders?

When a company makes a profit, it can pay dividends to its shareholders listed on the ‘record date’. The amount paid to each shareholder will be based on the number of shares that they hold. Dividends are usually paid two times a year and these payments are referred to as interim and final dividends. Companies pay dividends to shareholders in this way most often.

However, dividends can also be paid quarterly or as a special dividend where profit is especially high within the company. Each shareholder in receipt of dividends can choose to reinvest their dividends or take a cash dividend (receiving the cash value right away).

The record date is two business days before the payment date and this is the date that the company confirms who its shareholders are. Anyone listed as a shareholder on the record date will then receive their dividend payment on the payment date. If you have sold your shares before the record date, you wouldn’t be entitled to receive any further dividend payments.

Similarly, if you purchase shares after the record date, but before the payment date, you also wouldn’t be entitled to a share of the upcoming dividend payments. You would only be eligible for the future dividends declared by the company, when your name is listed on the record date. So timing is everything when it comes to investing in a company.

how are dividends paid to shareholders

 

Tax On Dividends

Dividends can be an important source of income for company shareholders. The amounts paid can range from a few hundred to thousands of pounds. As with all income, shareholders must understand the tax implications of receiving this additional income from dividends. We talk about tax on dividends here, because national insurance contributions are not usually required on dividend payments, regardless of reinvestment status.

Simply put, when a fund or shares are held in a tax-efficient account like an Individual Savings Account (ISA) or Self-Invested Personal Pension (SIPP) there’s no income tax, capital gains tax (CGT) or dividend tax to pay.

When held outside one of these wrappers, your investment is subject to income tax, capital gains tax (CGT) and dividend tax rules.

What you need to know:

  • Every individual has a tax-free dividend allowance. This is set at £500 for the 2024/2025 tax year. This is down from £1000 during the 2023/2024 tax year.
  • Anyone paid more than £500 in dividends will be taxed.
  • The amount you will be taxed is dependent on your personal tax bracket. For example, if you are a basic rate taxpayer – dividends over the £500 personal allowance will be taxed at 8.75%. If you’re a higher rate tax payer, the tax will be 33.75% and up to 39.35% if you are an additional rate taxpayer.
  • At the point of selling your shares, capital gains tax may be applicable if the sale price is more than £6,000 in 2024. Check gov.uk for current year rates, as they change each tax year.
  • If dividends are reinvested, they are treated as cash and taxed as outlined above if not placed automatically into a reinvestment scheme with the company who you have dividends with.

 

Understanding the tax liabilities surrounding dividends payments is a key part of shareholder finance management. Any accountant or tax advisor will be able to support you in understanding how much you need to pay in tax and the most tax efficient ways of managing your shares. Be sure to seek tax advice if you are receiving a dividend amount above the £500 allowance for 2024/25 or you’re expecting further dividends, as how much tax you’ll pay can be affected.

Tax On Reinvested Dividends

Rather than take the cash dividends payment, shareholders can choose to reinvest their dividends payments back into the company. This can be done via a dividend reinvestment plan (DRIP) or automatic dividends reinvestment (ADR). The benefit of these options is that there is no handling charge for the process and they can then own more shares in the company.

DRIP and ADR processes are available in most companies, but most are only available to UK residents for tax purposes.

If you choose to take the dividend payment as cash and then reinvest it yourself outside of the automatic or company routes noted above, the money is treated as if you received cash and will therefore be taxed inline with your tax bracket.

The benefit of utilising the company reinvestment process is that no tax will be due on those shares until you decide to sell them. When this time comes, capital gains will apply on the difference between the purchase price and the sale price.

Capital Gains On Reinvested Shares

Capital gains is a tax that applies when investors have made a profit on the sale price vs the purchase price of an investment, and in the case of this article, we’re looking at capital gains on shares.

Capital gains thresholds and payment bands are outlined on HMRC’s capital gains guidance pages.

To work out how much capital gains tax is due, you should calculate the amount paid for the shares minus the sale price, associated costs and tax reliefs due. There is a handy calculator available from HMRC, but it’s worth noting that capital gains ISN’T payable in the following situations:

  • If shares are gifted to your husband/wife/civil partner or a charity
  • When shares are put in an ISA or PEP
  • Premium Bonds or other government guilds
  • Qualifying corporate bonds
  • Any shares in employer SIPS (though capital gains tax will be payable upon the sale of those shares)
  • Some employee shareholder shares

 

When working out if capital gains tax is due and how much is owed, you should be careful to use the current market value to work out the liability owed. You should also be particularly vigilant if the shares were bought through an investment club, jointly with someone else, an employee share scheme or through a company merger as these circumstances may require alternative calculations.

capital gains on reinvested shares

Capital Gains Rates For Tax Year 2024-2025

We’ve outlined the option of reinvesting dividend payments vs taking them as cash, so let’s see how this impacts tax payments in each scenario.

The actual amount of tax paid on your capital gains will depend on the amount made after your personal capital gains allowance has been subtracted, and which tax bracket you fall into. For 2024-2025, capital gains allowances are set at £6000 – anything over this will be taxed at either 10 or 20%.

The table below illustrates which capital gains tax bracket you will fall into based on your personal tax bracket.

Income Tax Bracket Capital Gains tax rate on gains over personal capital gains tax allowance
Basic rate taxpayer ( Income £12,571 – £50,270)If you’re a basic rate taxpayer, the rate you pay depends on the size of your gain and your taxable income. See calculation example below.
Higher rate taxpayer (Income 50,271 – £150,000)20%

Basic Rate Taxpayer Calculations

  • Total up your taxable income – this is all income minus your personal income tax-free allowance of £12,570 for the tax year 2024/2025
  • Work up your taxable gains using the calculator on HMRC’s website
  • Deduct your £6000 capital gains tax-free allowance from your total taxable gains
  • Add this amount to your taxable income
  • If the total falls within the basic income tax band, you will pay 10% tax on the capital gains, but if it falls higher than the basic income tax band, you will pay 20% on any amount over the basic tax rate.

 

Tax on Cash Dividends For Tax Year 2024 – 2025

If taking your dividends as cash payments, the money will be taxed based on your personal tax bracket. Every worker has a personal tax free amount of cash that they can earn before they pay tax. This is currently £12,570. Any amount earned over this threshold but up to £50,270 will be subject to 20% tax.

When it comes to dividend taxation, there is another personal allowance to consider as everyone has a personal dividend allowance. This is currently £500 for the tax year 2024-2025. This means that you can receive £500 in dividends before any dividend tax is due.

The dividend allowance can fluctuate each tax year, so be sure to check the rates for your current tax year when working out your liabilities.

Tax Year Dividend Allowance
6/4/24 – 5/4/25£500
6/4/23 – 5/4/24£1000
6/4/22-5/4/23£2000

Dividend Tax Due Based On Income Tax Bracket 

Simply add your dividend income (over the £500 threshold) to your other income totals (from employment or self-employed work for example). This is the total that will set how much dividend tax is due. Be aware though that higher earners will pay tax at more than one rate.

Income Tax Bracket Dividend tax rate on dividends over the allowance 
Personal allowance (Income Up to £12,570)0%
Basic rate taxpayer ( Income £12,571 – £50,270)8.75%
Higher rate taxpayer (Income 50,271 – £150,000)33.75%
Additional rate taxpayer (Income over £151,000)39.35%

For example; If you receive £5000 in dividends on top of your £25,000 income from wages in the 2024 – 2025 tax year, you would have a total income of £30,000.

After you have deducted your personal allowance of £12,570, this leaves you with a taxable income of £17,430.

As this figure falls within the basic rate tax band, you would pay:

  • 20% tax on £12,430 of wages
  • No tax on £500 of dividends due to the dividend allowance
  • 8.75% tax on £4,500 of remaining dividends.

 

How Do You Pay Tax Owed On Dividends?

When you owe any tax, you will need to let HMRC know and settle your tax bill with them. This can be done via a self assessment tax return.

If you already use self-assessment to declare your earnings, you can simply add the dividends that fall between £501- £10,000 on the same form. If you don’t already use a self-assessment form, you need to let HMRC know about any dividends up to £10,000 over your tax free allowance of £500 so that your tax code can be changed.

You can advise HMRC via phone, or post and doing so will ensure that any tax due is taken from your wages or pension via PAYE systems.

For anyone earning over £10,000 in dividends you do need to fill in a self-assessment tax return, regardless of whether you need one for any other reason. This must be submitted by the end of the following tax year that you receive the income.

How To Reinvest Dividends Efficiently

Tax efficiency is important to investors so that they can make the most of their money and pay as little tax as possible. A DRIP is an example of an efficient way to reinvest dividends and can be particularly beneficial for long term investors as the automatic reinvestment helps to compound their returns and increase their ownership stake in the company over time.

Reinvestment schemes that allow for automatic reinvestment remove the need for brokerage commission fees, making them an attractive option for anyone looking to increase their stake in a company at no extra cost.

Remember though, whilst you avoid taxes now by reinvesting, you will be liable for capital gains tax at the point of selling the shares.

Are Dividends Taxed At Corporate Or Individual Level?

Dividends are taxed at two levels in the UK; corporation tax for the business, and income tax for the individual.

Corporation tax is paid on a company’s taxable profits and this includes dividend payments to shareholders. Income tax is charged on individual total income, including dividend payments received.

In both cases, the actual amount of tax paid depends on the tax bands the business or individual falls into.

There is no corporation tax due on dividends received by companies. This system of taxation ensures that companies are taxed on their profits before they distribute them to shareholders and that shareholders are then taxed on their income from dividends at their marginal rate of income tax.

Summary

To recap, dividend payment reinvestment can be an efficient way for investors to build their returns over time both by buying additional shares, and avoiding commission fees for brokers when reinvesting manually.

The key points to remember are:

  • Cash dividends reinvested yourself are taxed as income
  • Dividends reinvested through a DRIP scheme allow you to defer tax payments until you sell the shares when capital gains tax applies.

 

Overall, reinvesting dividends can be a good way to grow your investment portfolio over time. To determine the best route for you, consider your financial goals, tax rate brackets and your investment plans for the future. It’s always advisable to consult a professional tax advisor or accountant to discuss the most tax-efficient route for your finances, especially surrounding dividends, as they can be complicated to manage.

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