Frustrated by the prospect of generating an excellent financial return on your investments but then having to pay half of it over to the tax authority? This guide to how investments are taxed will help you understand the UK tax rules and structure your investments to ensure you pay as little tax as possible. The more tax you pay, the slower your investments will grow. Therefore, understanding how are investments taxed will help you become a better investor.
To learn about taxation in-depth, visit our shortlist of the best tax books, best corporate tax books and best inheritance tax books.
Disclaimer:
This article on how investments are taxed is relevant for UK tax residents only.
The UK tax rules continue to change, and while we strive to keep our content up to date, we’ll include links in the article directly to the HMRC guidance to empower you to check straight from the source yourself. This piece of financial journalism should not be considered financial advice, and you should not act upon it without further research.
If you need tailored and independent financial advice from a qualified professional, please look at our impartial guide to finding a financial adviser.
How are investments in shares and funds taxed?
Income and gains from shares and funds (including investment trusts, mutual funds, exchange-traded funds (ETFs) fall under the same taxation rules. Therefore tax isn’t usually the primary factor when searching for the best companies to invest in or the best funds to invest in.
Dividend income
Dividends received from shares or funds are taxed as a special category of taxable income.
Dividends are taxable in the period they are distributed to you. Funds which ‘accumulate’ i.e. reinvest dividends within the fund, do not distribute dividends at all.
The first £2,000 of dividends distributed to you within a tax year is tax-exempt under the Dividend Allowance. This remains at £2,000 for the 22/23 tax year. Check the latest dividend allowance here.
Any dividend income above the dividend allowance is taxed at a unique rate for dividends. The rate you will pay will depend on which tax bracket your other income (such as employment income) already takes you.
Period: 21/22 22/23
Basic-rate 7.5% 8.75%
Higher-rate 32.5% 33.75%
Additional-rate 38.1% 39.35%
You can verify the latest dividend tax rates here.
Therefore, if you have a salary of £60,000 per year. You will be a higher-rate taxpayer and therefore, dividend income will be subject to the higher rate of tax.
As dividend income also counts toward your total income used to decide your tax bracket, therefore some of your dividends could be taxed at different rates if the income straddles a boundary between the basic or higher rate, for example.
Dividend income tax rates for 22/23 are planned to increase following the 7 September 2021 announcement of tax increases to help fund health and social care.
Capital gains tax
If you sell shares or a fund investment (and do not buy it back within 30 days), this counts as a disposal for capital gains tax purposes. Profit made on the sale (measured as sales proceeds less initial investment cost) is exposed to capital gains tax.
You don’t have to pay capital gains tax on the first portion of gains, known as the annual exempt amount. For the 21/22 tax year this amount is £12,300.
You can check the annual exempt amount which will apply to you here.
This means that you’ll only be liable for CGT if your chargeable gain is greater than the annual exempt amount. £12,300 is a significant allowance per year. Savvy investors can avoid this tax by selling their investments in such a way to utilise as much of this allowance as possible each year.
For example, if you hold fund units worth £100,000 which you purchased for a total cost of £80,000 then you are sitting on a capital gain of £20,000. If you disposed of your entire holding in a single tax year, the gain would exceed the annual exempt amount and therefore you would pay CGT on the remainder.
However, if you sold £50,000 of your investment in one tax year (gain of £10,000) and £50,000 of your investment in the next tax year, and in each tax period, the total gain fell below the annual exempt amount. Therefore no capital gains would be chargeable. This requires planning but can save you a serious sum.
Capital gains tax rates for shares or fund investments are:
Period: 21/22 22/23
Basic rate 20% 20%
Higher / Additional Rate 28% 28%
You can double-check the latest CGT rates here.
Business asset disposal relief
Business asset disposal relief (formerly known as entrepreneurs relief) is a special reduction in CGT available to share investors in particular circumstances. If you qualify for this relief, you will pay only 10% in capital gains tax instead of 20% or 28%.
The rules for this relief are detailed, you can read them here. In summary; it is available if you:
Owned more than 5% of the companies shares for at least two years before you sold the shares
Worked for the company as an employee or director.
This relief is designed to apply to entrepreneurs who owned staked in their own personal business or even some angel investors who take a seat on the board of directors and actively work with a company to help it grow.
Other schemes are available for private investors who make equity investments into unlisted businesses. These are known as Enterprise Investment Schemes (EIS) and Venture Capital Trusts. You can read more about these in the linked articles or check out the best venture capital books.
How are the investments themselves taxed?
It is worthwhile appreciating that an investor isn’t only affected by tax collected by HMRC on dividends, gains and other income. Investors also pay tax indirectly on their investments, within the companies or funds they invest in.
Companies in the UK pay corporation tax of 19% on trading profits before they can be distributed as dividends (check the latest rate here). Companies that primarily act as investment funds, such as investment trusts, exchange traded funds and real estate investment trusts can qualify for a beneficial tax regime that reduces the amount of tax suffered within the fund. This can make these specialist investments a more tax-efficient way to hold investments and property.
Creating a tax shield – the stocks & shares ISA
To avoid investment tax with ease and simplify your tax return, you should consider opening a stocks and shares ISA.
A stocks and shares ISA is a type of UK stockbroker account that allows you to hold shares, funds, bonds and cash.
You do not need to declare, or pay tax on any dividend income, interest income or capital gains arising from investments held in a stocks & shares ISA. It’s that simple.
There are countless ISA providers in the UK. The full list of stocks & shares ISA providers is staggering. To help you find a good account, we’ve shortlisted the best stocks and shares ISAs on our page: the best stocks & shares ISAs.
The only catch is that the amount of money you can subscribe to any type of ISA is capped each year at £20,000 (check latest limit here). It goes without saying that you should consider utilising this allowance each year before making investments in generic investing apps or investing platforms because it’s a no-brainer to pick an account that will exempt your investments from tax.
How are investments taxed? Conclusion
I hope you’ve enjoyed this article explaining how investments are taxed. All successful investors have a sound grasp on how investments are taxed, and they try to minimise the amount of tax they need to pay. However, tax is never the primary factor a sophisticated investor would use to decide what to invest in. Tax is only a percentage of income or profit. Basic economics books and business books would expect more effort to be put into finding great investments which produce high levels of income and profit in the first place.
If you’d like to read more about finance, consider our shortlisted selection of tax calculators, financial planning and personal finance books.