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Is the new dividend tax increase unfair on SMEs?

In 2015 summer budget, Chancellor George Osborne announced that from April 6 2016 dividend tax would rise from by 7.5% to 32.5%. This is increase that will impact many SMEs and anyone receiving sizeable income from dividends.

Until now, small business owners paying themselves out of company dividends do so net of a 10% tax credit.  Basic rate taxpayers whose only or major source of income is a small salary and dividends, tend not to pay any personal tax.

The change announced by the Chancellor is set up with a new annual tax-free dividend allowance of £5,000 for each investor in the business.  For people whose dividend income is higher than that amount there will be the tax increase abolishing the 10% credit.

Most SMEs regard it as a tax to cover discounts being given to larger businesses. Corporation tax for large companies has in recent times been reduced from 28% to 20% whereas corporation tax for small companies has been 20% since 2011/12.

Shareholders of the large corporates are unaffected as most won't get more than £5,000 dividend.  However, the small business owners who take the most risk rightly get higher dividends.  The Government’s apparent justification that 95% are not affected has no real meaning.  Its response to petition said the increase is because company tax has reduced but most of that is for larger companies.

Now for a small business owner, if they are a basic rate tax payer, they will be paying 20% corporation tax and 7.5% dividend tax, but if they become a higher rate tax payer they will be paying 20% corporation tax and 32.5% dividend tax meaning they will pay a whopping 52.5% tax. By comparison, this is far more than what employees pay at 40% tax and 2%NIC, ie 42%.

The question is, would it be better to ditch the company and simply become an employee and pay less tax?  Some business owners feeling the pinch might seriously consider that, but in all likelihood the chance to run your own company with all of the other benefits that it brings will likely remain the most attractive option.

Small businesses facing the increase have a right to be disgruntled as the change is totally unfair and only demonstrates the Government’s commitment to larger corporations. HMRC has stated on its website: “This measure will help address the incentive for some people to set up a company and make payments as dividends rather than as wage.”

So because of ‘some people’ all small business owners have to pay what appears to be an unfair price.

In summary, it’s doubtful this tax rise will change anything. Dividends are still going to be cheaper as compared to sole trader class 4 NIC of 9% or Employee NIC for taking higher salary though the margin of saving has reduced.