Types Of Shares Proceeds
To understand how shares are taxed, it is important that we first understand the types of incomes that investors receive for holding them.
- First, we have the dividends which refer to the portion of profits paid by a company to its shareholders.
- The amount to be paid is determined by the company’s board of directors and paid to a class of its shareholders. They can be issued as cash payments, shares of stock or other property.
- Another form of income results from the sale of shares and is known as capital gains. A capital gain is achieved when the selling price of a share is higher than the buying price. When the selling price of a stock is lower than the buying price, the investor incurs a capital loss.
- Finally, we have the type of dividends that the investor gets for buying a share of an investment portfolio of securities. These types of shares will not be covered in this guide.
- Before we get started on the tax treatment of the above types of incomes, let me clarify that I am not a tax expert and the information given in this post should not be considered as tax advice. This guide is meant to help you get a glimpse of what is expected when filing for shares income.
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Income Tax on Dividends
When it comes to tax on share dividends, every tax jurisdiction has its specifications on when and how investors should file. In the UK, the investor is only required to pay tax only if the dividends go above the specified dividend allowance in a given tax year. According to the HMRC, investors do not have to pay tax on the first £5000 of their dividend income no matter what non-dividend income they have. However, since April 2018, the tax-free dividend allowance has been reduced to £2000.
If the dividends are above the given tax allowance, then the tax paid by the investor depends on which Income Tax band they are in. It is also important to note that dividends that fall within the investor’s personal allowance do not count towards their dividend allowance.
HMRC specifies that for investors with dividends payments above £2000 and are on the basic rate band, the tax rate on the dividend income is 7.5%. Likewise, investors in the higher rate band and the additional rate band are required to pay 32.5% and 38.1% respectively. There tax exemptions for some types of dividends which we will discuss later in this post. Here are some examples to help you understand the HMRC tax treatment of dividends.
Examples in Real Life
An investor receives a dividend income of £10,000 from shares outside of an ISA and a non-dividend income of £6200 from a service contract. The personal allowance given for that year is £11000. With a dividend allowance of £2000, the taxable dividends amount is £8000.
Add these to the non-dividend income of £6200 and then subtract the personal allowance which in this case is £11,000. The taxable amount will be £3200 which when taxed with the basic rate band of 7.5% will result in a tax bill of £240.
Now let’s say the investor’s dividend income from shares is £1500 and their non-dividend income is £10,000. The dividend amount is within the £2000 allowance and therefore the investor is not required to pay any tax on share dividends. Their non-dividend income is also within the personal allowance and is, therefore, tax-free.
It is important to note that even when you have not taxes to pay, you may be required to file especially if you are on self-assessment. A self-assessment filing is meant to determine if the taxpayer is responsible for completing a tax return when needed.
My recommendation is that you consult a tax expert to help you determine if you are required to file and how to go about the process.
Capital Gains tax On Shares Sale
When an investor sells their shares at a price higher than the buying price, they make a capital gain. Just like other types of income, the capital gains are subject to tax depending on the tax jurisdiction.
In the same way as the tax on dividends, the capital gains have a specified amount in which the investor is exempt from being taxed. This amount varies with the tax year and therefore should be clarified with the responsible tax body.
To determine the taxable amount of the capital gains, you need to deduct the tax reliefs for that year plus the losses made in that tax year and those brought forward from previous years. This means that you can carry forward all the losses made in the previous years and set them against gains as they arise in the future.
Also, if you sell shares and use all the proceeds to buy identical investments, you are not required to pay capital gains tax. However, the term identical cannot be loosely translated and therefore it is important to consult a tax expert for clarification.
Another important thing to note is that a share transfer to a spouse does not incur any capital gains tax. However, if the transfer is to any person other than a spouse, it is deemed as a disposal and therefore subject to capital gains tax at the current market value.
An investor buys 500 XYZ shares at £50 per share. After 1 year, the share price has risen to £100 and the investor decides to sell. The capital gains from this sale will be £25,000 ((500*100) – (500*50)). Let’s say the capital gains tax-free allowance is £11,700.
To calculate the taxable amount, take the capital gain which is £25000 and subtract the capital gains tax-free allowance of £11,000. The taxable amount will be £14,000. If you are on the basic-rate income tax bracket, you will pay 18 percent of the taxable amount and if you are on the additional rate taxpayer bracket, you will be 28 percent of the taxable amount.
Assume that apart from the sale of shares, the investor sold property with a capital gain of $20,000 and is also employed with an annual income of $50,000. The personal income tax allowance is £11,850. To calculate the taxable amount, you will need to add the capital gains from the share sale and the property sale and then deduct the capital gains tax allowance.
In this case, the total capital gains will be £45,000 and to get the taxable amount, you will need to deduct £11000 to get £34,000. On the personal income, the investor should deduct the personal income tax allowance and then add the balance to the taxable capital gains. The investor should then take the total taxable income and apply the rate given for their tax bracket to determine the total amount to pay in taxes.
A stamp duty is a type of tax paid at the transfer of shares and the registration of share capital. According to HMRC, when an investor buys shares electronically, they are required to pay a stamp duty reserve tax of 0.5% on the transaction.
For shares that are bought non-electrically, the same rate is applicable only that the transaction must be valued over £1000. For purchases worth £1000 and below, the investor is exempt from this tax and they are not required to report.
However, they must complete first exemption certificate on the back of the stock transfer form and send it together with the share certificate to the registrar of the company they have bought shares in. It is important to note that while the 0.5% rate may seem little, it can amount to significant costs for frequent traders.
Unlike other types of taxes on shares, the investor/trader is not responsible for filing for the stamp duty tax. Instead, the investor’s broker automatically adds it to the cost of share purchase and pays the taxman on behalf of the investor.
According to the HMRC, an investor who buys shares in a market outside the UK is not required to pay the stamp duty. Again, this type of tax on shares is not a requirement for the purchase of gilts and corporate bonds. We will not go into much detail since the filing is done by the broker and not the investor.
What Type Of Shares Income Is Exempt From Tax?
As mentioned at the very beginning of this post, not all income from shares is taxable. According to the HMRC, who are responsible for taxing individuals in the United Kingdom, shares that are in an individual saving account (ISA), those in personal equity plans (PEP) and the ones in share incentive plans (SIPs) are not subject to capital gains tax.
Also, the investor is not required to pay tax if they give shares as a gift to a spouse or to a charity. The shares held by an employee shareholder are also exempt from tax even though this depends on when they got them.
The HMRC specifies that the shares held by the employee must have been worth at least £2000 when they got them. However, the employee shareholder is subject to capital gains tax on shares that were worth over £50,000 when they got them.
In addition to this, the employee shareholder must pay capital gains tax on gains over £10,000 made during their lifetime. When planning on taxes on shares, it is important to evaluate the various ways you can utilize the accounts mentioned above to reduce your tax bill.
Understand Tax Requirements
Whether you are an experienced or a new investor, understanding the tax requirements for your jurisdiction will help you determine the best ways to reduce your tax bill.
While it is always prudent to engage a tax professional to guide you on the details, it is important to have a basic understanding of what is expected and what you need to do to be on the safe side of the law. Going against the rules set by your tax jurisdiction whether knowingly or unknowingly can result in hefty fines.
When it comes to taxes on shares sale, there are many ways an investor can lower their tax bill and for these, it is best to engage an experienced tax expert. When looking to invest in the stock market, the tax implications should be among the top areas to address for investors and should review every now and then to ensure adherence and also revise tax avoidance strategies.