For a Chancellor in a Government which made vociferous pre-election pledges to help the UK’s small businesses, George Osborne did a very peculiar – although some would say duplicitous – thing in his Budget: he announced his intention to change the current dividend tax system, which he described as arcane.

If he’d announced an increase in the price of petrol by so much as a penny, there would have been howls of protest from the public and the media but his efforts to raise an additional £2.6bn in divided taxation next year (2015/16) and £8.5nb by 2020/21 have passed by without so much as a murmur. How did this go unnoticed by intrepid journalists and taxation watchdogs?

The implications of this for some of the UK’s smallest businesses are weighty: from April 2016, directors of limited companies will incur no tax liabilities on the first £5,000 of dividends they receive. Beyond that, they’ll become liable to three new taxation rates: a basic rate of 7.5 per cent, a higher rate of 32.5 per cent and an eye-watering 38.1 per cent for additional-rate taxpayers. Under the new system, a director earning a salary of £11,000 who takes £50,000 a year in dividends will pay an additional £1,277 in tax to HMRC next year.

As Mr Osborne will have been fully aware when he began casting around for new tax opportunities, there are 5.2 million limited companies in the UK according to the latest estimates by Companies House. The overwhelming majority – 99.3 per cent – are defined as small, employing less than 50 people. In fact, 4 million of them hire no employees at all. Recently, these director-only limited companies have been rising in number by 2 per cent per year.

It seems likely that this trend wasn’t lost on Mr Osborne. He appears to have noticed there has been a shift among small business-owners from self-employment to operating through a limited company, and he appears also to have decided to undermine the tax advantages of doing so. Currently, provided a little clever accounting is deployed, the national insurance and income tax paid by directors is, for the same income, less than that paid via self-employment or vehicles such as limited liability partnerships (LLPs).

However, the political and economic pressures in the current climate converge on cracking down on anything that could be construed as tax avoidance. Richard Murphy, economic adviser to Labour leadership contender Jeremy Corbyn and a chartered accountant (he heads TaxResearch UK) has urged a minimum capital requirement of £20,000 to deter the use of limited companies, which he believes have been used for tax avoidance purposes (limited company directors, he suggests, can save a walloping 70 per cent on their tax bill compared with their tax liabilities under self-employment rules). Should Mr Corbyn win the leadership contest, and should he be elected Prime Minister, this deterrent proposal could well be enacted.

The boom in director-only limited companies is probably also being fuelled by the recent expansion of consultancy contracts in both the public and private sectors. Most limited company directors will retain this model of remuneration if dividends are taxed at 7.5 per cent; however, massaging the rate up toward 12.5 per cent may well result in literally millions of directors shutting down their limited companies and shifting toward alternatives: self-employment, LLPs and Umbrella Companies.

 

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