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Tax hikes mean SMEs 'reinvest less in business'

As new tax rates on dividends arrive, UK small business owners have been taking more of their profits out of the business rather than reinvesting them.

UK SMEs paid out 94% of their profits as dividends last year, significantly up from 63% the year before, according to accountancy firm Moore Stephens.

Total dividend payments made by UK SMEs increased to £28.3 billion in 2015-16, up from £17.5 billion in 2014-15, as changes to the taxation of dividends became law in April 2016.

Most SME business owners now have to pay higher taxes on dividends because of changes announced by George Osborne in the July 2015 post-election budget. Moore Stephens says these changes will significantly increase the tax burden for businesses.

The Government has introduced an allowance that means the first £5,000 of dividend receipts in a tax year will now go untaxed; however, business owners and other taxpayers receiving dividends now have to pay a higher marginal tax rate on the remainder, as of 6 April 2016.

The revised tax rates on dividends are as follows:

  • basic rate taxpayers now have to pay 7.5%; previously they were not liable to taxation;
  • higher rate taxpayers have to pay 32.5%, compared to 25% previously;
  • additional rate taxpayers now pay 38.1%, up from 30.56%.

Mike Cooper, partner at Moore Stephens, said the new dividend tax has already had a big impact. 

"Ahead of the changes, SME owners reduced reinvestment into their businesses in 2015-16 compared to the previous year, and the changes will continue to have an impact on future plans."

The EU referendum may have been another key factor, he said. 

"It is possible that the uncertainty over the Brexit vote also contributed to the rise in profits paid out as dividends by SMEs. Some business owners may have acted on a just-in-case basis and taken out extra funds to support themselves through any post-Brexit instability."

Businesses will see a big difference in their finances going forward, he added. 

"From now on, business owners will have to take out a higher percentage of profits in order to maintain the same post-tax income. Many small business owners are basic rate taxpayers, who will be particularly hard hit by the changes and may face difficulties when looking to grow their businesses."

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