Taxing questions for smaller firms

MONEY TALK
By Simon Massey
Partner, Menzies Chartered Accountants

Simon Massey of Menzies Chartered Accountants

Fears of bigger tax bills for thousands of small, family-run businesses were raised last month after a High Court ruling against husband-and-wife team Geoff and Diana Jones who own IT consultancy Arctic Systems.

HM Revenue & Customs argued 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.

But Simon Massey of Menzies Chartered Accountants argues that not all husband-and-wife businesses should be concerned.

There is no doubt that the Arctic Systems case does set a legal precedent but, in my view, it does not mean every small business run by a husband-and-wife team should now be bracing itself for an enormous backdated tax bill.

That's because the arrangements which Mr and Mrs Jones had set up were somewhat unusual.

Let's look at the particular facts of this case.

• Mr Jones was effectively the sole fee-earner in the company

• The company had a turnover of £91,000

• Mr Jones worked full-time but drew a salary of only £7,000

• Mrs Jones did 4 hours a week administration and drew a salary of almost £4000

• After expenses and corporation tax, the couple shared the remaining £60,000 equally in dividends.

It is true that Mr & Mrs Jones paid less tax and national insurance on their income because they took dividends than they would have done if they had drawn larger salaries. However, this was not the substance of the HM Revenue & Customs' case against them.

Tax advantage

The crux of the HM Revenue & Customs' case against Mr and Mrs Jones relied on an obscure aspect of the law of settlement, a legal area which most people only stumble across when they are making a will.

It is important not to be alarmist in estimating how many people will be affected

Essentially it applies when, to minimize tax liability, you pass assets to a third party allowing them to enjoy those assets but not to control them.

The Inspector of Taxes judged that Mr Jones had given away his right to receive a part of his income to his wife, effectively in a settlement, in order to obtain a tax advantage.

He argued that the £4,000 Mrs Jones was paid as a salary was fair recompense for the work she did. The additional £30,000 she received in dividends was deemed to be rightfully her husband's property.

As we now know, this view has been upheld by two levels of the tax appeal system and the result is that Mr Jones will be taxed on all of the dividend income, and the liability is likely to be all at a 40% tax rate.

Don't panic

In my view, the application of this decision is restricted to those companies where there is only one 'breadwinner'

This case will be used by the HM Revenue & Customs as a precedent to argue that many more family companies have made unacceptable arrangements to minimise their tax bills.

However, it is important not to be alarmist in estimating how many people will be affected.

Some accountants have warned that 200,000 small firms could suffer, but I believe it will be closer to the Inland Revenue's estimated figure of 30,000.

That's because, in my view, the application of this decision is restricted to those companies where there is only one 'breadwinner'.

Husband-and-wife teams where both partners make a significant contribution to the company will not face a clampdown.

There is no doubt that some people will be concerned that the Arctic Systems precedent will affect their family firm and I would urge them to seek professional advice immediately.

This area of the law is extremely technical and it would be foolhardy to attempt to negotiate its intricacies without professional expertise.

The opinions expressed are those of the author and are not held by the BBC unless specifically stated. The material is for general information only and does not constitute investment, tax, legal or other form of advice. You should not rely on this information to make (or refrain from making) any decisions. Always obtain independent, professional advice for your own particular situation.