Chancellor of the Exchequer George Osborne has radically reformed the tax on dividends.
The Conservative minister said the existing system is “complex and archaic” and was designed to offset double taxation on profits.
He said that from April 2016 the dividend tax credit would be scrapped and replaced with a £5,000 tax-free allowance.
Mr Osborne said: “Those who either pay themselves in dividends or have large shareholdings worth typically over £140,000 will pay more tax.”
“Over a million people will see their tax cut. It’s an important reform.
“It comes into operation next year, and with our personal allowance and our new personal savings allowance it means that from April – on top of the New Isa – people will be able to receive up to £17,000 of income a year tax free.”
The government will set the dividend tax rates at 7.5 per cent for basic rate taxpayers, 32.5 per cent for higher rate taxpayers and 38.1 per cent for additional rate taxpayers.
Mr Osborne said dividends paid within pensions and Isas will remain tax-free and unaffected by the changes.
HM Treasury expects these changes to reduce the incentive to incorporate and remunerate through dividends rather than through wages to reduce tax liabilities.
Analysis for the Treasury said this will reduce the cost to the Exchequer of future tax motivated incorporation by £500m a year from 2019/20.
Rajiv Vadgama, director at Baker Tilly, said: “I think it is a welcome change and it will put a stop to a lot of the administration around dividends.
“£5,000 is a pretty generous allowance - most people probably get a lot less than that.”