Dividend disaster for one million family firms and freelancers: Workers face paying up to £1,100 more in tax because of way they take their income

Under plans announced by Philip Hammond yesterday, the dividend allowance will fall to £2,000 in April 2018 over concerns that it is being exploited by some workers

More than a million family-owned businesses and freelance workers will lose out because of the tax crackdown on dividend payments.

They face paying up to £1,143 a year more in tax because of the way they choose to take an income.

Many families who run newsagents, restaurants, shops, accountancy firms and other businesses take their earnings as company directors through dividend payments, rather than a monthly salary.

That means they pay lower tax rates than salaried employees and can earn £5,000 a year tax-free on top of the standard £11,000 personal allowance.

Under plans announced by Philip Hammond yesterday, the dividend allowance will fall to £2,000 in April 2018 over concerns that it is being exploited by some workers.

As well as small business owners and their families, the perk is used by celebrities, sports stars and contractors in industries such as IT to cut their bills.

But thousands of these workers have set up so-called personal service companies so they can keep more from the taxman.

As directors, they ensure any income they receive goes into the firm first. They then take it as a dividend, not a salary. As well as an extra £5,000 tax-free, basic-rate taxpayers pay just 7.5 per cent tax rather than the 20 per cent charged on salaries.

Higher-rate taxpayers must pay 32.5 per cent rather than 40 per cent and top-rate taxpayers who earn more than £150,000 pay 38.1 per cent rather than 45 per cent.

To cut bills further, many top earners also pay dividends to relatives named as directors, which allows them to use the £5,000 allowance multiple times.

The crackdown will force a basic-rate taxpayer to hand an extra £225 a year to the taxman.

A higher-rate 40p taxpayer will pay an extra £975, while a top-rate 45p taxpayer faces an extra bill of £1,143, according to figures from accountancy firm Deloitte.

The measure will bring in £2.7billion over the next five years – the largest sum of any policy announced by the Chancellor yesterday.

It will also affect savers with money in shares who rely on dividends for income.

Mr Hammond said half of the 2.27million people affected were company directors; the others were investors who typically held more than £50,000 outside an Isa. He described the perk as an ‘unfairness’ that handed a tax advantage to a small proportion of the workforce.

Budget documents said: ‘This measure will ensure that support for investors is more effectively targeted and the total amount of income they can receive tax-free is fairer and more affordable. It will also partially reduce the tax difference between the self-employed and those working through a company.’

The measure will bring in £2.7billion over the next five years – the largest sum of any policy announced by the Chancellor yesterday

Ed Molyneux, founder of FreeAgent, a business software company, said: ‘This is potentially devastating for freelancers and contractors across the UK.’

Elaine Clark, an accountant and founder of tax firm Cheapaccounting.co.uk, which will be hit by changes, said: ‘The Government only introduced the £5,000 dividend allowance a year ago and now it’s changing the rules again.

‘It’s a real muddle and it means that small business owners like myself can’t plan one year to the next.

‘Speaking as an entrepreneur, at every turn it feels like the Government is doing more to kick you, without appreciating how hard it is to set up on your own. Being a business owner is not a nine-to-five job, nobody pays into your pension and there’s no holiday pay.

‘But the Chancellor’s announcements leave us business owners feeling disenfranchised about the whole system of taxation – it doesn’t make me want to work harder because it feels like you’re taxed more for doing well.’

Many families who run businesses take their earnings as company directors through dividend payments, rather than a monthly salary. That means they pay lower tax rates than salaried employees and can earn £5,000 a year tax-free on top of the standard £11,000 allowance

Personal service companies were once an obscure device used by professional contractors – often in the IT industry – who held short-term roles across several firms each year, sometimes at the same time.

However, use has become more common among other professionals in recent years, with many using them to slash as much as tens of thousands of pounds a year in tax and national insurance payments.

Jason Hollands, director of financial advisers Tilney, said: ‘This measure is clearly aimed at employees and directors of small businesses who might remunerate themselves partly or wholly through dividends rather than salary.’

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