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Last Updated: Thursday, 6 December 2007, 16:34 GMT
Tax rules tighten on family firms
Tax return
The new law will draw in more tax from husband-and-wife businesses
The government is proposing new laws to stop some husband-and-wife businesses cutting their tax bills by sharing their income as dividends.

Earlier this year HM Revenue & Customs lost a test case in the Lords when it tried to challenge the tax arrangements of Geoff and Diana Jones.

The couple's IT consultancy, trading as Arctic Systems, had successfully avoided paying 50,000 in income tax.

The government argued that the "income splitting" involved was artificial.

"The government believes that the fairness of the income tax system is undermined if some individuals are able to dissociate themselves from income that they would have received in order that the income is taxed in the hands of another individual at a lower rate," said the Treasury.

"The [new] legislation would apply only where a tax advantage is gained through non-commercial arrangements and where the shifted income is in the form of a company distribution or share of partnership profits," it added.

Artificial

Mr and Mrs Jones had for several years shared the income from their jointly-owned business by paying themselves dividends from the company.

Over the course of a four-year legal campaign, HMRC argued that in such cases the partner earning most money should not be able to reduce their tax bill by shifting some of the income to their spouse, who might otherwise earn little or nothing.

The authorities said that Mr Jones had cut his own salary to an artificially low level, just so he could give his wife some of his money as dividends.

The couple argued, successfully, that the arrangement was perfectly legal and, until 2003, had also been regarded as such by HMRC and the accountancy profession.

The government responded to the legal defeat by announcing, at the time of its recent pre-Budget report, its intention to plug what it sees as a "tax loophole".

In its consultation document it says it wants to stop "income splitting" where, in reality, the husband, wife or civil partner "plays either no role or only a minimal role in the business".

Francesca Lagerberg, of accountants Grant Thornton, said: "The government has pursued this issue with great force and the result must come as a bit of a shock to the taxpayer following the Arctic Systems win at the House of Lords in July."

Foregone income

The government says it will not try to stop such arrangements where they have been made on a genuinely commercial or "arms-length" basis and that its plans will not affect the majority of small businesses.

The support of the spouse may well be the difference between the business succeeding and failing
Andrew Hubbard, CIOT

Where it does, the person who has forgone income will have to account for it as their own income on their tax returns, and pay tax on it.

Andrew Hubbard, of the Chartered Institute of Taxation said: "In theory this might seem fair, but the reality is that family businesses do not and cannot possibly operate on a fully arms length basis.

"One spouse might be the main income generator but he/she may well be totally unable to run the business without the full support of their spouse.

"The support of the spouse may well be the difference between the business succeeding and failing," he added.

The new laws should come into effect next April.



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