Liz Slee, head of media at Enterprise Nation, looks at the upcoming changes to the dividend allowance for business owners.

At a recent meeting of the Small Business Taskforce, one of the members declared it was "no longer worth setting up a limited company".

He was referring to the next changes to the dividend allowance, due to start in April, which will see tax applied from a £2,000 threshold rather than £5,000 paid to directors in dividends.

Historically, dividends have been an extremely 'tax-efficient' way to be paid for the directors of limited companies. Before the 2015 post-election Osborne budget, dividends for basic rate taxpayers were completely tax free.

The introduction of the new allowance by the government back then sparked a campaign but it clearly hasn't influenced policy-makers.

In his March budget last year, Philip Hammond announced the allowance was to be reduced yet again, coming into force in a few weeks. The long-term plan is that it will bring £930m into government coffers from tax take by 2020/21. 

The government's intention is also to "lower the incentive" for individuals to incorporate.

According to the independent research body, the Institute for Fiscal Studies, choosing between employment, self-employment and incorporation is only a pertinent question for the smaller, owner-managed firms as larger companies must incorporate for legal reasons. Therefore this is another issue that targets small firms.

The IFS argues that tax rates, to include income tax and National Insurance Contributions (NICs), for these groups should be aligned after taking account of capital investment.

But it comes at a time of increased costs for businesses including auto-enrolment and new digital compliance under Making Tax Digital, so is it fair to hammer them again?

According to the think tank The Entrepreneurs Network (TEN), evening-out the tax playing field makes good economic sense, but more should be done to help entrepreneurs invest in their businesses in a tax-efficient way as a spin-off.

Philip Salter, founder of TEN, said: "It makes economic sense for the government to iron out the perverse incentives that push people to incorporate solely for tax reasons.

"And with an average predicted loss of £315 in 2018 for 2.27 million individuals, it's unlikely to push significant numbers of people to opt for self-employment over incorporation.

"But the government should be clear that this is part of a plan for more fundamental reform of the sort set out in the Mirrlees Review. As with any tax changes, there will be losers, but with enough notice and forward guidance business owners can plan and mitigate against the risks.

"The government should be offering carrots as well as sticks though. Alongside rationalising the tax system, we should be better incentivising business owners to invest by allowing firms to immediately deduct capital expenses, as argued by Sam Dumitriu in our report, A Boost for British Businesses."

Clive Lewis, head of enterprise at the Institute for Chartered Accountants England and Wales, said advice around business format to entrepreneurs is now a more complicated decision: “Deciding which business format - sole trader, partnership or limited company - best suits your business is very complicated.

"Unless you have a specific need to form a limited company (such as, you want to sell shares in a business) it is probably best to start as a sole trader and consider forming a limited company once there is a clear pattern of the business profitability.

“It not just Income Tax and Corporation Tax rates to consider but the sole trader has to pay Class 4 National Insurance. Changes to dividend taxation make the decision even more difficult. This is why we advise start-up businesses to talk the issue of business format through with a qualified chartered accountant."

Find out more about the government's reforms here and see more detail here.

Is our business tax system really perverse?  We’d like to hear your views. Please leave a comment below.

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