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Last Updated: Wednesday, 30 April, 2003, 13:59 GMT 14:59 UK
Small firms under tax attack
John Whiting
Analysis
By John Whiting
Tax partner, Pricewaterhouse Coopers

A number of small companies - typically small businesses owned jointly by a husband and wife team - have been startled to receive demands from the Inland Revenue for significant additional sums in tax.

The Revenue say the recipients have been avoiding tax - and so have to hand over more than they had any idea was due.

These claims for back tax are typically for tens of thousands of pounds.

So what is behind this apparent new targeting by the Revenue?

The settlements rules

The settlements rules that the revenue is citing have been in place for many years.

The rules are longstanding anti-avoidance legislation and in many ways are understandable.

Essentially, they stop you passing income to someone else in the family, or giving income or assets to someone else on the basis that you will have it back later, all in an effort to reduce the overall income tax bill.

I feel like we've been singled out
Geoff Jones

So it is the settlements rules that stop parents giving assets to their young children with the aim of using up the children's tax allowances and reducing the family's overall tax bill.

Do companies get caught?

Let's assume Fred and Jim own and run a successful small company. Their wives Freda and Jinny don't have any income of their own.

So Fred and Jim get the company to give their wives some special preference shares that just give nice big dividends, but don't give their owners any say in running the company.

Result? The wives have got some income to mop up personal allowances and lower tax rates, instead of the income all being taxed on Fred and Jim at 40%.

Second result? The Revenue attacked a similar case to this and won under the settlements rules a few years ago.

The point was that the wives were being given something that was just a "right to income" in a "bounteous act".

How far does it go?

Tax advisers accepted that result - do something strange with your share capital and you are at risk, if you like.

But what no one thought was affected was the routine splitting of ownership of a company between husband and wife.

And it's this that now seems to be in the firing line.

What has been routine for many years is for Fred, if he was setting up on his own, to split ownership of Fred's Enterprises Ltd (FEL) with Freda.

Freda would get a small salary for doing secretarial work; Fred would draw a salary as well; and the net profits would be paid out by way of dividend - with Freda getting her share.

The Revenue's argument against this routine arrangement is that if FEL's income stems mostly from Fred's work, then he should get the income.

They claim that Fred has given Freda a right to income - the dividends that she gets on her shares in FEL.

Thus they want to tax the company's income (apart perhaps from Freda's salary) as if it's all Fred's.

Is this new - I thought settlements had been around for ages?

The Revenue claim they have always argued that the Fred/Freda situation was unacceptable tax avoidance. To me - and many others - it's just routine planning.

It's more than tax planning - it's how the couple want to run their business.

After all, Freda isn't just getting dividends - she is a shareholder and has all the rights and obligations that go with the shares.

It is for reasons such as this that I think the Revenue's current attack goes too far.

The Revenue accepts that if the business has a significant asset base - perhaps it owns a factory - then Freda is getting rights over those assets as well as the income. So that's not caught by the rules.

But if FEL's income is essentially just Fred's efforts - that's in the firing line.

Readers will appreciate that in this day and age there are a lot of businesses in that ambit - the knowledge economy that the UK is developing takes a lot of people into their own small business.

And if Fred is off doing his IT work, or media work, or plumbing or whatever, you can bet that Freda is doing a lot to make sure that his business keeps going.

Help - I've got a demand - what do I do?

If you are faced with a tax demand, the first step has to be to review it carefully - and unless you're convinced the Revenue have made a mistake, get advice, preferably from a chartered tax adviser.

There are grounds to oppose the Revenue's claim, as I've indicated. But we are in a complex area and people need to tread with care. There are already some appeals going in over similar situations to Fred's.

The Chartered Institute of Taxation is trying to assess how many of these demands are around. It would helpful to hear from anyone faced with a settlements claim - to techtemp@ciot.org.uk so some statistics can be generated.




SEE ALSO:
Child tax credit worries continue
26 Apr 03  |  Business


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