How are shares taxed in the UK?

What are the taxes on shares you have to pay in the UK?

In the UK, there are several important taxes that retail clients may need to pay on returns generated by their stock market investments. The most important are:

Capital Gains Tax - which is paid on realised capital gains made when you sell an asset
Dividend Tax - which is paid on dividend distributions made to you by companies within your portfolio
Stamp Duty - which is applicable whenever you buy shares

When investing, it is extremely important to consider any tax implications that will directly affect your total returns. A key consideration is use of the most common tax shelters:

Premium Bonds - where all 'prizes' won are free of tax
SIPPs - into which you can contribute from your gross income
ISAs - into which you can contribute from your net income

Each of these shelters have their own advantages and drawbacks. Read more below.

Capital Gains Tax

Capital Gains Tax (CGT) is the tax due on the profit acquired when you sell an asset that has increased in value. Importantly, it is only the gain on the asset that is taxed, not the total value of the asset.

For example, if you buy a share for £50 and then sell it some years later for £150, it is the gain of £100 that is subject to tax. Further, CGT is only applied when the gain is realised – or in layman's terms, at the point you sell the asset.

It's also relevant to note that capital losses can be offset against gains in the same tax year. To illustrate, if you made a gain of £100 on asset A and suffered a loss of £50 on asset B, you can generally reduce the total capital gain to just £50.

Capital Gains rates depend on your tax status – higher rate taxpayers pay 20% on all chargeable assets, excluding non-primary property, which is charged at 28%.¹ This falls to 10% and 18%, respectively, for basic rate taxpayers. These rates only apply to shares held for more than one year – shares owned for less than a year are charged at the standard income tax rate.

However, you do benefit from some tax-free allowances, including the Personal Allowance (see below) and a specific Capital Gains Tax-free Allowance. This is set at £6,000 and at £3,000 for trusts – though it's worth noting this figure has shrunk in recent years.

These tax rules create some complex tax planning incentives:

• investors are motivated to keep assets as long as possible to benefit from compounding returns
• investors who have made a gain over the course of nearly a year and who think the asset may fall in price must weigh the extra Capital Gains due if selling before the year is over
• political changes mean that investors need to consider whether beneficial or negative changes to CGT rates or allowances might occur

These are just three examples among hundreds, but the key point is that the CGT system makes careful tax planning a necessity for most investors.

Dividend Tax

Dividends are the payouts received by investors who own shares in companies that choose to release excess cash to investors rather than reinvest in the business. These companies tend to be larger established corporations, such as those occupying the top spots of the FTSE 100.

Dividend Tax, therefore, is the tax due on these dividend payments.

However, you only pay Dividend Tax on dividend income that falls above the dividend allowance. This is currently set at £2,000, but you can also benefit from the Personal Allowance of £12,570, which would leave you with an allowance before tax of £14,570. In reality, though, this remains at £2,000 for most employees.

Thereafter, any dividend income will be charged at a basic rate of 8.75% for basic rate taxpayers, 33.75% for higher rate taxpayers and 39.35% for additional rate taxpayers.² Remember, these allowances and rates are subject to change.

Just like CGT, Dividend Tax rates and allowances create some incentives:

• if you're self-employed through a limited company and generate most of your income through dividends, it can make more sense to invest in growth stocks over dividend royalties
• as Dividend Taxes are lower than CGT under £50,000 and higher thereafter, investors sometimes let the tax tail wag the investing dog when making decisions
• growth stocks and dividend stocks become comparatively tax-efficient, depending on your age and income, which skews the market

It's worth noting that a decent accountant, and perhaps an independent financial advisor, may make sense for individuals looking to maximise their tax efficiency.

Stamp Duty

Stamp Duty is due whenever you buy shares, even within almost all tax shelters. You usually pay a flat tax of 0.5% on the total transaction. If you buy your shares electronically, you pay Stamp Duty Reserve Tax, and if you use a stock transfer form, you'll pay duty if the transaction exceeds £1,000.

There's also a 1.5% tax due if you transfer shares into some 'depositary receipt schemes' or 'clearance services'. Importantly, Stamp Duty (just like with real estate) is only due when you buy, not when you sell. If you buy shares from a broker, they will include the cost within the contract.

Again, as the tax is only paid when you buy, this tax incentivises investors to trade less frequently and hold shares for long durations. A 0.5% tax may seem small, but this can bite into compounded returns over time.

Personal Allowance

A Personal Allowance is the amount of money you can earn without needing to pay any tax – currently set at £12,570. This can be increased slightly, for example, if you claim a Marriage Allowance or Blind Person's Allowance.

However, the so-called '60% tax trap' occurs between earnings of £100,000 and £125,140. Your Personal Allowance decreases by £1 for every £2 earned in this tax bracket.

This allowance operates on a 'use it or lose it' basis; you can't carry forward any unused allowance into future tax years.

Taxes on shares

When might you not pay tax on shares?

Are shares always taxable income? Do I need to pay tax on stocks? These are fairly common questions – and the short answer is: not always.

There are many tax shelters in place designed to incentivise investment, which are too broad to cover here. These include venture capital schemes, the Enterprise Investment Scheme, Personal Equity Plans, Share Incentive Plans, most gilts and some corporate bonds.

As a general rule, investors participating in many of these shelters will have already received professional financial advice.

However, the three most common tax shelters are:

• Premium Bonds: you do not have to pay any tax on 'prizes' won on investments made into Premium Bonds. While the return is not guaranteed, the average return can be competitive for higher-rate taxpayers
• Self-Invested Personal Pensions (SIPPs): you can choose to invest up to £60,000 per annum from your gross income into your pension, and there is an unlimited Lifetime Allowance. You can access your pension from the age of 55, at which point you can take a £268,275 lump sum tax-free, and the rest is subsequently taxed as normal income³
• Individual Savings Accounts (ISAs): you can invest up to £20,000 per annum from your net income in a Stocks & Shares ISA. There is no CGT or Dividend Tax due on returns within this type of account⁴

These tax shelters, combined with the above rates and allowances, create even more tax planning opportunities and problems:

• the tax rate on early SIPP withdrawals is set at 55%, and your scheme provider will often charge early exit fees. However, ISA withdrawals are penalty-free
• the government reserves the absolute right to change any and all rates, allowances and shelters at any time
• the most tax-efficient investor would invest £60,000 of gross income into their SIPP, £20,000 of net income into their ISA, and then cash out investments just under the allowances for dividends and Capital Gains. However, this ignores changing financial needs over time
• all else being equal, SIPPs can generate more income over time, but ISAs are more accessible
• punitive taxes in certain brackets, including the high-income child benefit charge and 60% tax trap, make investing excess income within the bracket into a SIPP almost absurdly tax-efficient

Overall, a combination of SIPP and ISA contributions may shield investments from the full force of the taxman for most investors. One final tax to consider is inheritance tax – there are complex rules when leaving assets to your spouse, children or other relatives, and these require specialised advice.

¹ Capital Gains Tax Overview – GOV.UK
² Tax on Dividends: How Dividends Are Taxed – GOV.UK
³ SIPP Tax Relief and Benefits Explained – Bestinvest
⁴ ISAs Explained – Legal & General