Tax surprises for personal investors

The 1998 Budget contains at least one hidden tax increase for personal taxpayers in receipt of dividend income. The impact may be quite wide ranging, affecting most notably personal investors in Irish quoted companies, including many employees who have acquired shares through employee profit sharing or share option schemes and shareholders in family companies.

The impact is all the more surprising because the changes in tax treatment of dividends go right against the trend of the personal tax reductions announced in the Budget.

The table shows the income tax payable on a dividend of £100 paid by an Irish company, after taking account of the tax credit available. It assumes that the company's dividends carry a full standard tax credit.

The calculations also show the net cash value of the dividend after all taxes. Assuming that there are no further reductions in tax rates over the next few years, the effective tax on the dividend will increase by more than a third over the next two tax years for a higher rate taxpayer.

This is bad enough but the rate increase over the same period in the case of a standard rate taxpayer is almost threefold. The reason for these increases is simple - the reduction by approximately one half in the rate of tax credit for dividends paid on or after December 3rd, 1997 and the projected abolition of the credit from April 6th, 1999.

Shareholders in Irish quoted companies are in for a further surprise resulting from the changed tax treatment of "scrip dividends". These have been offered by many quoted companies since tax rules were liberalised in 1993 to allow shareholders to take additional shares in lieu of a cash dividend.

While the latter was subject to income tax, the additional (scrip) shares were not. Taking a dividend in the form of scrip shares was also an effective way of building up a shareholding without incurring dealing costs or a stamp duty liability.

Scrip shares received on or after December 3rd, 1997 will attract exactly the same tax treatment (including the attribution of a tax credit if received prior to April 5th, 1999), as if a cash dividend had been taken. This change means that a shareholder opting to take shares instead of cash will have to face a tax bill.

There is some bad news too on the capital gains tax because from April 6th next the annual CGT personal exemption will drop from £1,000 per individual to £500 and this will not be transferable between spouses.

These changes in the rate of tax credit and the tax treatment of scrip dividends will probably have a negative impact on the attractiveness of the stock exchange to the private investor. However, special portfolio investment accounts, which continue to benefit from a 10 per cent rate of tax will become more attractive.

Admittedly, with reducing corporate tax rates, the reserves available to Irish corporates for the payment of dividends will increase and theoretically they can afford to pay greater cash dividends. But this may not be entirely desirable for other reasons.

So is there anything that an Irish corporate could do for its shareholders which would be tax attractive? One opportunity may lie in the buying back of existing shares. Following an amendment introduced in a previous Finance Act, a shareholder who sells his share back to a quoted company in which he has invested, is dealt with under capital gains tax rules.

As a result of the reduction in the capital gains tax rate from 40 per cent to 20 per cent which was announced in last week's Budget, any gain arising attracts a relatively modest tax cost. This affords an opportunity to quoted companies which cannot find an attractive home for surplus cash to reward their shareholders in a very tax efficient way, even allowing for the reduction to £500 in the annual personal exemption.

Gearoid Deegan is a Senior Tax Manager with Price Waterhouse