Changes to simplify the dividend tax process for HMRC could cost small businesses in the long run

Small business owners making the most of the tax-free dividend allowance in the UK have already seen an impact on their savings and the cash available to them, due to a significant reduction that saw the allowance shift from £5,000 to £2,000 in April 2018. And now, family owned companies, small business owners and individuals could be faced with a further tax disadvantage if recommendations laid out in the recent report by the Office of Tax Simplification (OTS) go ahead.

The OTS is the independent adviser to the UK government, created to improve and simplify the tax process for all tax-payers. Following their latest review, the OTS have identified that the current system used to calculate tax allowance on dividend income is too 'complex' and have put in place recommendations that would ensure that, in future, the process for paying tax on dividends becomes less complicated.

Dividend tax is paid on income generated by shares held outside ISAs and pensions, which also exceeds the government tax-free allowance. The OTS report suggests a solution that would both simplify dividend income tax and redress the tax amount paid on dividends to bring these rates in line with typical income tax rates.

The proposal could see tax-paying business owners paying more in tax in the long run, with tax rates paid on dividends enhanced by 125%. The current basic rate of 7.5% could increase to 20% to match the basic income tax rate, higher rate taxpayers would potentially see a shift from 32.5% to 40%, as well as additional rate taxpayers from 38.1% to 45%, meaning more tax paid with less cash to take away.

Should these changes meet HMRC approval, the increase in dividend tax rates are likely to have a long-term effect on company owners and investors. Business owners who extract profit from the company as a salary or dividend could see a significant drop in the cash that they take out of the company each year, with a consequential negative impact on personal budgets and living expenses.

The changes could also spell bad news for investors who earn dividends from shares and funds in a business. With less return on investment, the option to provide financial backing to businesses is likely to become a less appealing option, and investors themselves also standing to lose.

If you are a small business owner, being aware of changes to tax allowances and rates of payment will help you to prepare for the potential impact on profit, salary, and finance. If you are concerned that you may be affected by changes to tax rates, the Tax team at LWA are on hand to offer the most up to date advice and guidance, helping you to negotiate the complex landscape of business tax and ensure your compliance with legal requirements.

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