Dividend tax changes represent genuine tax rise for hard-working small businesses

When the Chancellor announced changes to how dividends are taxed in his Summer Budget, it was suggested there would be no tax increase, except for people receiving dividends of more than £140,000 a year.

This reassurance always seemed unlikely however, and HMRC’s recent explanation as to how the new tax system would work proves our point.

In fact the new regime represents a genuine tax rise for many people. The Conservative Party’s first solo Budget in many years delivers a kick in the teeth for entrepreneurial small businesses and is not an incentive for them to work harder and strengthen the UK economy

Under the current system, if you pay yourself a salary from your company of less than £10,600, the current personal allowance, and take the rest of your income in dividends, you will not pay any Income Tax on salary or dividends until your total pay exceeds £42,385.  

Under the new rules this will no longer be the case, from 6 April 2016.  Apart from your personal allowance, the first £5,000 of dividend income will be tax-free, after which all further dividends will be taxed at a minimum rate of 7.5 per cent.  So somebody paying themselves £42,385 out of their own company would have £15,600 tax-free (£10,600 personal allowance and £5,000 dividend allowance) with the next £26,785 taxed at 7.5 per cent, giving a tax bill of £2,008.88. (Actually, the personal allowance for 2016-17 will be £10,800, so the tax bill will be £15 less, at £1,993.88).

This might not seem much, but it is £2,088.88 more than under the current regime.  If your income exceeds £42,385, dividends will be taxed at 32.5 per cent on top of the £5,000 allowance, and if you are a high earner with more than £150,000 a year, the rate of tax on dividends will be 38.1per cent.  This is an Income Tax rate increase   on dividends of 7.5 per cent at every level.  It is a major tax increase for everybody –particularly small business owners who have traditionally paid themselves a small salary and large dividends.

The new system has been put forward as a form of tax avoidance measure, to discourage people from incorporating their business to take advantage of lower rates of Corporation Tax.  The current headline rate of Corporation Tax is 20 per cent but set to fall to 18 per cent over the life of this Parliament, compared with Income Tax rates of up to 45 per cent with National Insurance contributions on top.  

As mentioned, most dividends are paid by small owner managed companies and represent the profits of the average entrepreneurial small business person.  So many people perceive this measure as an extra tax charge on the small business person to pay for the lower Corporation Tax rate which favours some of the very largest companies in the country.

In contrast, while the drop in Corporation Tax rates is intended to encourage inward investment by multinationals, the headline rate of Corporation Tax is actually a relatively minor part of the decision-making process when choosing whether or not to invest in a given country.  It comes well down the list after other considerations such as infrastructure and access to an educated and motivated workforce.  In any case, the UK already had the joint lowest Corporation Tax rate in the G20 group of countries and it seems unlikely that a 1 per cent drop in the rate will make a material difference as to whether or not companies invest in the UK.

What we in business would much prefer to see are tax cuts for hard-working entrepreneurial business owners, not tax rises, so that people can retain more of their hard-earned profits and spend them in a way that enhances the economy, rather than paying more tax to the government.

The Miller Partnership has many years’ experience dealing with small business remuneration issues, and Pete was the Inland Revenue’s in-house expert on dividends.

For further advice or assistance please contact Pete on 0116 208 1020 or email pete.miller@themillerpartnership.com