Yahoo Finance Our £1,980 National Grid dividend is a foretaste of a harsh new tax regime
As growing numbers of Questor correspondents are realising, the taxation of company distributions - whether these are regular dividends or one-offs - is becoming more complex and onerous.
This is relevant to today's Income Portfolio column because we are set to benefit substantially from a special dividend being paid by National Grid. It arises from its £4bn disposal of the majority of its UK gas distribution business in a transaction that was completed last month.
Last week National Grid said that £3.1bn of the proceeds would be distributed as a special dividend. The rest will be fed back to shareholders via share buybacks.
The special dividend of 84p per share will be paid in a month's time - see timeline, right.
Questor bought National Grid for this portfolio (where the object, you'll remember, is to generate a sustainable 5pc income from a £500,000 initial sum) on Oct 6. We spent £25,000 when the shares were trading at £10.58. This netted us around 2,360 shares.
For a number of reasons explored in subsequent Friday columns National Grid has been one of the portfolio's worst performers, with its price falling as low as £8.91 in December.
It has since rallied and a January dividend payout totalling £358 on our holding means at yesterday's closing price of £10.07 we are down on a total return basis only 3.5pc. This is good.
Even better, we are now anticipating a special dividend payment of £1,980.
But in the real world, this brings tax problems.
Many Questor readers are used to being offered a choice when special distributions like this make their welcome appearance. Shareholder documents would normally offer two routes: take the payment in the form of "B" shares, which could be immediately encashed; or elect for a special dividend.
Lower earners or non-taxpayers historically would have opted for the latter because until April 2016 dividends for them were more benignly taxed. But higher-rate taxpayers would have chosen the former share-distribution route, because they could then be taxed on a capital gains basis, enabling them to use their annual capital gains tax exemption.
No longer. Unremarked by most, the previous government's overhaul of dividend taxation stripped companies of their ability to offer such shareholder-friendly choices.
George Osborne announced the move in 2014's Autumn Statement, saying he would "remove the unfair tax advantage provided by special purpose share schemes, commonly known as 'B share schemes'", in order to ensure that all payments via such schemes "will be taxed in the same way as dividends".
A number of Questor readers have already contacted our offices lamenting National Grid's decision to distribute all of this money as income whereas it is, in fact, not the company's decision at all.
Tina Riches, a partner in accounting firm Smith & Williamson, said: "The 2015 Finance Act removed the choice from businesses as to how these distributions could be made. There are now very limited circumstances where companies can make payments to shareholders as capital."
Under the previous regime many shareholders would have paid no tax. Under the current set-up, everyone has an individual dividend allowance of £5,000 after which tax is paid at 7.5pc (basic-rate taxpayers) and 32.5pc (higher-rate taxpayers).
In the case of National Grid you would need to own just 6,000 shares outside of an Isa or pension in order to exhaust your dividend allowance with just this special distribution - quite apart from National Grid's other, regular dividends (to which it is happily committed).
To make matters worse, last month's Budget outlined a further change from April 2018 which would see the allowance drop from £5,000 to £2,000. The subsequent election announcement has meant a delay in legislating this change, but it is probably on the cards regardless.
More analysis of dividend taxation and other investment taxation appears in tomorrow's Your Money section.
Update
We've pinned hopes on Lloyds Banking Group being a major contributor to both income and capital returns for this portfolio, investing £20,000 on Dec 9 at 62p.
Yesterday's first-quarter figures confirmed our expectations that with costs of insurance mis-selling petering out, and Lloyds taking advantage of scope to improve its interest margins (in part by reducing interest paid to depositors), the bank should become a "dividend-paying machine".
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