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I see growing concerns about how capital gains tax (CGT) or bank taxes could hurt UK shares ahead of the upcoming Budget (28 October). The Chancellor has reportedly ruled out a CGT rise, while a higher bank surcharge is widely tipped.
But I think investors may be watching the wrong risk. Sure, a Budget crash would be painful. But a dividend-tax rise would be slower, quieter and more damaging to the way many UK investors build income.
Why a crash isn’t the main risk
Markets usually price Budget risk before the day of delivery. That’s why bank shares have wobbled on reports that the Chancellor could raise the surcharge on bank profits from 3% to 8%.
The BBC reports that reversing the 2023 cut could raise about £2bn, although nothing’s been confirmed.
That could hurt banks. But a broad crash normally needs something bigger: a recession, a gilt-market shock or a global event. A tax change, even an unwelcome one, doesn’t automatically trigger that.
The bigger issue is dividends. From 6 April, dividend tax rose to 10.75% for basic-rate taxpayers and 35.75% for higher-rate taxpayers. The additional rate remains 39.35%. Those rates apply outside ISAs and pensions, where most dividend income’s sheltered.
Please note that tax treatment depends on the individual circumstances of each client and may be subject to change in future. The content in this article is provided for information purposes only. It is not intended to be, neither does it constitute, any form of tax advice. Readers are responsible for carrying out their own due diligence and for obtaining professional advice before making any investment decisions.
So the question isn’t whether shares fall on Budget day. It’s whether income shares become less attractive after tax.
The income shares most exposed
High-yield companies such as Legal & General, Imperial Brands and Aberdeen Group (LSE:ABDN) are more exposed than growth businesses. Their appeal depends heavily on the cash they hand to shareholders.
Aberdeen’s a useful example. It paid a 7.3p interim dividend in September, unchanged from a year earlier, and its full-year dividend for 2025 was 14.6p per share. With a yield currently hovering around 6.2%, it certainly deserves a closer look.
But that yield’s attractive only so long as it can keep up payments. With an earnings payout ratio estimated at 69% and a cash payout ratio of 80%, it has better overall coverage than L&G and Imperial Brands. That suggests its dividend is sustainable for now, but that could still change.
If dividend tax rises again, a taxable investor’s after-tax yield falls. To earn the same return, they may demand a higher pre-tax yield. That can pressure the share price, even if the underlying business is fine.
In short: a dividend cut would hurt Aberdeen’s reputation, but a tax rise hurts the investor’s return if the company does nothing. That’s the risk.
How investors can counter this
ISA and pension investors don’t pay dividend tax, so a sell-off in income shares could create opportunities for them. The same share may look less appealing to a taxable investor but more interesting inside a wrapper.
Buybacks also matter. They can be paused more easily than dividends, without sending the same negative signal. A company balancing a sensible dividend with buybacks may cope better if tax rules tighten.
The takeaway’s simple: use ISAs and pensions where possible, check whether a high yield is covered, and avoid panic-selling before the Budget.
The Budget may not crash UK shares. But it could quietly reshape the dividend trade. The real risk isn’t a red headline on Budget day – it’s investors realising their income’s worth less after tax.
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Mark Hartley owns shares in Legal & General.
This story originally appeared on Motley Fool
