The Chancellor said the dividend tax credit will be replaced with a new tax-free allowance of £5,000 of dividend income for all taxpayers.

He said it would “simplify the taxation of dividends”. The Government will set the dividend tax rates at 7.5% for basic rate taxpayers, 32.5% for higher rate taxpayers and 38.1% for additional rate taxpayers but there will be no tax credit.

There will be an increase of 7.5% where dividend income exceeds £5,000.

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Previously, individuals in receipt of dividends benefited from a 10% tax credit which for basic rate tax payers meant they could enjoy their dividend tax free. Higher rate tax payers paid an effective 25% tax rate.

Matt Hall, head of tax at Wilkins Kennedy, said: “These latest announcements will hit entrepreneurship where it hurts because there will be no incentive to grow a business into a larger organisation as those who receive significant dividend income will pay more. An entrepreneur with profits of £100,000 will see their annual tax bill increase by over £3,500.

“Small business already feeds the economy and are significant contributors to their communities as they create wealth and employment as they grow. Therefore to target them with further taxes could see entrepreneurship in the UK take a nosedive.”

Dominic Slattery, managing director of tax planning and investment specialist OneE Group, said: “ “Perhaps a less welcome change is the effective increase in the dividend tax rates for shareholders. Dividend tax rates are generally lower than PAYE salaries and the Government has deemed this to be an unfair advantage.

"However, in my view, this fails to recognise the significant risk taken by entrepreneurs who start up their own businesses and create jobs. We should be encouraging young, talented individuals to take such risks and help grow the economy. The increase in dividend tax rates will discourage people from doing so.”

Nimesh Shah, partner at Blick Rothenberg, said: “The Conservatives pledged in their manifesto that they would not increase income tax, National Insurance and VAT for the duration of Parliament. The changes to dividend taxation announced in the Summer Budget are effectively an increase to personal income tax, going against the so-called tax lock.”

Angela Murfitt, Financial Planner at Fairstone Financial Management, said: “The changes announced by the Chancellor to the dividend tax system will create more complexity, so individuals who are remunerated by way of dividends will need to consider whether this shape of remuneration is the most tax efficient.”

Mr Osborne said: “We’ve cut Corporation Tax from 28% to 20% over the last Parliament, one of the biggest boosts British business has ever seen. We can’t take it lower than that while such strong incentives are created for people to self-incorporate and pay the lower rates of tax due on dividends.

“The dividend tax system was designed partly to offset double taxation on profits. But the system has not changed despite sharp reductions in corporation tax. Lower rates are creating rapidly growing opportunities for tax planning.

“We have inherited a very complex and archaic system.

“So I am today undertaking a major and long overdue reform to simplify the taxation of dividends. Those who either pay themselves in dividends or have large shareholdings worth typically over £140,000 will pay more tax. 85% of those who receive dividends will see no change or be better off. Over a million people will see their tax cut.”

Dividends paid within pensions and ISAs will remain tax-free and unaffected by these changes.