By Paul Lewis
BBC Radio 4's Money Box
The chancellor may have a shock for some self-employed
Self-employed people who have turned themselves into a company to reduce their tax bill could end up paying thousands of pounds in extra tax under proposals "buried away" in pre-Budget papers and not announced by the chancellor.
Anne Redston, a partner in accountants Ernst & Young, warned on BBC Radio 4's Money Box programme that the chancellor was planning a tax clampdown on people who ran one-person or small businesses.
"This is possibly the time bomb of this year's budget. Buried away deep within the Treasury papers is a promise that he is going to take the right amount of tax from owner managers of small incorporated businesses.
"And the worry is that he is going to put National Insurance on the dividends paid to these owner managers," she told the programme.
Until this week, thousands of self-employed people and the owners of small businesses could save tax by forming a small company and employing themselves on a low salary. They would then take the profits of the business out as dividends.
Tax rates on dividends are lower than on earnings and they do not attract National Insurance charges. So what is known as 'incorporation' could save individuals thousands of pounds a year.
But paragraph 5.91 of the pre-Budget report could spell an end to saving tax this way. It says:
"The government is concerned that the longstanding differences in tax treatment between earned income and dividend income should not distort business strategies, or enable reductions by tax planning of individuals' tax liability."
And it warns:
"The government will therefore bring forward specific proposals for action in Budget 2004, to ensure that the right amount of tax is paid by owner managers of small incorporated businesses on the profits extracted from their company."
That could affect not just people who incorporate in the future but anyone who has taken this action in the past. And Anne Redston warns:
"Incorporation is relatively straightforward. But the opposite - unincorporation - is much more difficult."
BBC Radio 4's Money Box was broadcast on Saturday, 13 December, 2003.