Many sole traders have used the loophole to cut their tax bill
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A tax loophole which has enabled small businesses to avoid paying tax and national insurance has been closed by the chancellor in the Budget.
Mr Brown said some businesses had used a zero tax rate "not to invest" but to avoid tax and national insurance by redefining their income as dividends.
However, under the changes announced in the Budget, these dividends will be taxed at a rate of 19%.
The Federation of Small Businesses called the move "unfair".
'Least offensive option'
In his 2002 Budget, the chancellor cut the rate of corporation tax on the first £10,000 of profits made by small businesses to zero.
This meant a sole trader with annual profits of £15,000 could save about £3,000 tax if they switched to incorporation.
But in paragraph 5.91 of December's pre-Budget report, Mr Brown warned that the Treasury planned to introduce measures to ensure "the right amount of tax is paid by owner-managers of small incorporated businesses".
And in Wednesday's Budget speech, Mr Brown said: "I will close the loophole by taxing distributed profits at 19p."
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This would bring the tax on distributed profits for those small companies "into line with other companies", he said.
Simon Sweetman, of the Federation of Small Businesses, described the chancellor's decision as "unfair".
He said: "It is amazing how quickly a concession to encourage enterprise can become a loophole."
"This move will hit ordinary family businesses hardest when it is the loopholes exploited by the rich that cost the Exchequer money."
But Russell Gardner, a small business expert with accountants Ernst & Young, said the chancellor's decision to close the loophole was "probably the least offensive option" small businesses could have expected.
Investment allowances
He said the zero rate of tax had been "a window of opportunity" which had now closed.
"The motive to incorporate for the smallest of businesses will no longer be there," he said.
The chancellor said he would increase - initially for one year - investment allowances for the smallest businesses from 40% to 50%.
"Overall, a small company making pre-tax profits of £25,000 and investing in plant and machinery who has paid over £5,000 in tax in 1997 will pay £2,735," he said.
Separately, the chancellor announced a freeze on rates of corporation tax and capital gains tax.
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This move will hit ordinary family businesses hardest when it is the loopholes exploited by the rich that cost the Exchequer money
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