Controversial tax increases, nicknamed IR591, currently being drafted by chancellor Gordon Brown will leave IT contractors and owners of small firms who take income as dividends facing "huge" tax increases in this year's Budget.

The tax proposals are buried in paragraph 5.91 of the government's December 2003 Pre-Budget Report: "The Government will [...] 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."

Peter Penneycard, national director of tax at accountancy and business advisory firm PKF warned: "These weasel words are likely to result in much larger income tax and NIC bills for small businesses throughout the UK."

The climate of fear, uncertainly and doubt among IT contractors and small business owners began when the chancellor said he wanted to "tax equally" salaries and dividends paid to owner-managers, but refused to explain how he intends to achieve this objective.

In the absence of any clarification from the Treasury, financial analysts have said that the most likely scenarios to increase the tax burden on small companies will center on one or a combination of the following options:

• Treat dividends as salary
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• Charging NIC on such dividends
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• Imposing an investment income surcharge
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• Removing the tax credit from the dividends
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• Abolishing the 0 per cent starting rate of corporation tax

Each of these different methods of taxing dividends will produce different tax charges. For example, an owner-manager whose company makes profits of £35,000 in a year may take a salary of £5,000 and dividends of £25,000. If the dividends are taxed as salary, the owner would see a reduction in his income of £5,324 - over 15 per cent of the company's total profits.

"Whilst there will be little that the business community can do to combat these changes, we have developed an easy-to-use tax calculator that owner-managers can use to be forewarned if not forearmed," Penneycard added.

PKF's tax calculator here is designed to allow firms to the potential cost of the most likely five ways that the Chancellor may choose to impose the tax increases.

On 17 March UK business should know how the chancellor will impose this tax increase and PKF promised its calculator will be updated to reflect the Treasury announcements. ®

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