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What do dividend tax changes mean for SMEs?

Incoming tax changes affecting dividend payments could encourage more small and medium-sized businesses to consider using an employee share scheme to reward and retain talented staff.

A growing number of employers are recognising that they need to reward key staff, or risk losing them, as job market competition steps up. While employers are reluctant to introduce blanket pay increases, the incoming changes to dividend taxation, which were announced in the Summer Budget, are encouraging some to consider introducing an employee share scheme.

Take up of employer-backed sharesave (SAYE) schemes and share incentive plans (SiP) has been growing steadily as the job market has improved and the incoming changes to dividend taxation could emphasise this further.

As part of the changes, which will take effect in April next year, a new £5,000 dividend income allowance will be introduced. This allowance means that any dividend payments received by individuals after this date, up to a value of £5,000 in any tax year, will be completely tax-free. Recognising the incentive this could provide for those benefiting from employee share schemes, some employers are considering introducing them for the first time.

However, the tax changes affecting dividend payments are not going to be widely beneficial and business owners, or those with a significant shareholding, may need to rethink the way they extract cash from the business. For example, the rate of tax that will apply to dividends paid to higher rate tax payers is rising to 32.5p for every pound.

The majority of business owners prefer to take cash out of the business in the most tax-efficient way possible and traditionally, dividend payments linked to their shareholding have been regarded as preferable to drawing a salary. While they will remain a tax-efficient option for many, the increased tax liability that will apply to dividends paid to higher rate and additional rate tax payers means that there is now less difference compared to the current rate of income tax.

Another area where care needs to be taken is when sole traders are considering incorporating their business. Currently, one of the main reasons for incorporation is to reduce the business owner’s personal tax liability by opting for remuneration consisting of a mix of salary and dividends based on their shareholding. This can have the effect of reducing the overall ‘take’ from the business as it grows.

Incorporation may still be the right route for a fledgling business set on growth and any decision to incorporate should not be based on tax considerations alone.

Manny Sahota is tax partner at accountancy firm Clement Keys

This was posted in Bdaily's Members' News section by Clement Keys .