Small firms face higher tax bills

The case could mean hefty tax bills for small businesses

A High Court ruling in favour of HM Revenue & Customs (HMRC) may mean bigger tax bills for thousands of small, family-run businesses.

The case concerned husband and wife team Geoff and Diana Jones who own Arctic Systems, a small IT consultancy.

HMRC argued that Mr Jones had unfairly transferred some of his income, in the form of share dividends, to Mrs Jones to benefit from her lower tax status.

The ruling could now mean bigger bills for many businesses, one expert said.

Income transfer

What Mr and Mrs Jones did was not out of the ordinary. There will be tens of thousands of family-run business that will be caught out by this John Whiting, PricewaterhouseCoopers

Mr and Mrs Jones were hit by a HMRC ruling last year that income from company dividends, received by a non-earning or low-earning spouse who is co-owner of the business, should be taxed at the same rate as the main earner's income.

Mr and Mrs Jones, backed by tax campaigners, took their case to a HMRC tribunal last year. When they lost, they took the case to the High Court.

"What was going on in this case was that the husband - who was an IT consultant - was transferring income in the form of Arctic Systems shares, which then produced a dividend, to his wife.

"The income would then be taxed at Mrs Jones' lower income tax rate," John Whiting, tax partner at PricewaterhouseCoopers told BBC News.

Mr Whiting added that many small family-run businesses had similar tax arrangements to Mr and Mrs Jones.

"What Mr and Mrs Jones did was not out of the ordinary. There will be tens of thousands of family-run businesses that will be caught out by this," Mr Whiting said.

Don't panic

However, BDO Stoy Hayward tax partner Stephen Herring said the case was unusual and businesses should not panic.

It was understandable why..(HMRC) chose to take action Stephen Herring, BDO Stoy Hayward

Mr Herring said HMRC's investigation was prompted by more than just the sharing of the tax liabilities.

Mr Jones had accepted a greatly-reduced salary, severely limiting his income, so he could share increased dividends with his spouse, Mr Herring said.

"The facts of this particular case are, arguably, extreme. Accordingly, it was understandable why (HMRC) chose to take action," said Mr Herring.

"We consider that very few family companies should be affected as a result of this High Court decision, provided that HMRC is consistent and only applies the ruling in such extreme cases."

A spokeswoman for HMRC said businesses "that comply with the long standing settlements legislation (that has been in place since 1936) will not face higher tax bills".

In the meantime, following the latest defeat at the High Court, the couple could take their case to the Court of Appeal.