e-mail Paul Lewis on paul@deadline.demon.co.uk
Unless the the Government changes its mind, a new tax on savings will start next April. It will take nearly £25 million a year directly off 300,000 older people with low incomes. And it will hit hundreds of thousands more who have money in personal equity plans. Not many people know about it. And fewer still understand it. But if you have shares and you pay no tax it will affect you.
The new tax will hit dividends paid to shareholders. And the people it will affect most are those whose incomes are too low to pay any tax. The changes are complex - and that is how the Government has got away without being challenged on it for nearly a year. But suddenly people are beginning to realise the effects. This is how it works.
Like other investment income, dividends paid to shareholders are taxed at 20 per cent for basic rate taxpayers and at 40 per cent for those who pay higher rate tax. However, the way this tax is paid and collected is very strange. A dividend is paid to a shareholder with the basic rate tax already deducted. The dividend cheque comes with a tax credit which is equal to the basic rate tax due.
Suppose the dividend is £80. That is paid to the shareholder together with a tax credit of £20. The total is £100 divided up so that the shareholder gets 80 per cent and the company keeps 20 per cent which it eventually passes to the taxman when it settles its own tax bill. What happens next depends on the taxpayer.
It is this last group - the people who pay no tax - who will be hit by the tax change. From April 1999, they will not be able to reclaim the tax which has already been deducted. They will still get their dividend of £80. But they will not be able to reclaim a penny of the tax that has been paid, even though their income is too low to pay tax. These poorest pensioners will lose £20 out of every £80 they get in dividends.
Like everything to do with tax, the actual changes are not quite that simple. And more of the detail is explained later. But the basic point - and the desperately unfair one - is that non-taxpayers with small shareholdings will lose a quarter of their investment income from April 1999.
WHO IS AFFECTED?
The people who will be worst hit are those who have a small number of shares, sometimes inherited, in other cases from building society windfalls or a privatisation issue. Whatever their source, these shareholdings are usually not large and may bring in anything from a few tens to a few hundreds of pounds of income in a year. Many of the people affected will be married women or widows who do not pay tax. If their income is less than £5410 a year (£104 a week) then they can currently reclaim the tax already paid on their dividends from the Inland Revenue. The Government has said that around 300,000 people aged 65 or more reclaimed a tax credit on dividends from their shares in 1995/96. There will also be some younger ones but it cannot say how many. The average refund was £75 - more than a week's pension for many people. That cost the Government £22.5 million. From April next year those people will lose that money.
The change will not affect the amount of tax paid by people who are taxpayers. But it will make the tax system itself more complicated and that will inevitably mean more mistakes. From April next year the tax credit paid with a dividend will be 10 per cent rather than 20 per cent. At the same time, the basic rate of tax due on a dividend will be reduced to 10 per cent. So basic rate taxpayers will not owe any more tax. And the higher rate of tax on dividend payments will be reduced from 40 per cent to 32.5 per cent. The rather complex arithmetic means that higher rate taxpayers will also pay the same amount of tax as they do now. In other words, there will be no extra tax on anyone with an income high enough to pay tax at all. The only people who will suffer are the pensioners who are too poor to pay tax.
PEPS AND ISAS
However, people with higher incomes may also suffer from the change indirectly. The new rules which prevent tax credits being reclaimed by non-taxpayers will eventually apply to tax-free investment funds of all sorts. Pension funds were the first to be attacked. Indeed, the original purpose of removing the right to reclaim tax credits, which was announced as part of Labour's first Budget in July 1997, was to quietly take around £3.5 billion a year from pension funds. That change started at once. And in the latest Budget in March this year, the Government announced that Peps, and the new Individual Savings Accounts, will also be hit from April 1999. The change will be phased in over five years but ultimately it will considerably reduce the value of these tax-free investments.
At the moment, fund managers running Peps and ISAs can reclaim the tax credits on dividends paid into Peps and ISA. They will still be able to reclaim the tax credits from next April. But as the credit will have been reduced from 20 per cent to 10 per cent, the tax relief will be halved. And five years later, in April 2004, this concession will disappear and no refunds of credits will be paid into Peps or ISAs. Even when the tax refund is cut in half from April there will be little advantage for basic rate taxpayers to invest in an ISA or to leave money in a personal equity plan as the charges will eat away most of the tax gain. And from 2004 there will be no point at all in taking out one of these investments. For most people all the tax advantages will have disappeared completely.
The only people who will benefit by having money invested in a Pep or an ISA are those who pay higher rate tax - income from Peps and ISAs will continue to be free of that - and the wealthy 90,000 who pay capital gains tax. The rest will do as well buying their own shares or investing in an ordinary unit trust.
The Government is coming under increasing pressure to stop this change. Nick Gibb, the Conservative MP for Bognor Regis and Littlehampton, has been arguing for a concession for pensioners and has moved amendments to the current Finance Bill as it makes its way through the House of Commons. So far, the Government has refused to give way. But Paymaster General Geoffrey Robinson has now agreed to look again at the problem. Although what exactly he will propose is unclear. Mr Gibb told Saga Magazine
"This change won’t really come home to older people until next April when they apply for their refunds and don't get them. Then the political pressure will be enormous and I am absolutely certain the Government will do something. But what I don't know. They might make an exception for older people who are below the tax threshold. We'll have to wait and see."
But John Whiting, a partner at accounts Price Waterhouse, is not so confident.
"For the Government the amount involved - £22.5 million - is frankly peanuts. But I am not so sure they will do anything. If they do then they may allow some poorer individuals to reclaim the tax credit. But that will be half as valuable next year so they will still lose a significant amount."
The Government may announce its decision as early as July. So there is just time to write to your MP to tell them how you feel.
e-mail Paul Lewis on paul@deadline.demon.co.uk