Hundreds of thousands of small businesses will face a combined tax bill of half a billion pounds under proposals unveiled by Alistair Darling yesterday.

The measures, which ban “income-shifting” arrangements favoured by family businesses and partnerships, will raise £485 million in revenue by 2011, according to the Government’s Pre-Budget Report yesterday.

Chas Roy-Chowdhury, head of taxation at ACCA Global, said that small businesses had been hit by a “double whammy . . . with the near-doubling of the capital gains tax rate when they sell an interest in a business and the confirmation by the Chancellor that he will be looking at the income-splitting”.

The Treasury said that it would crack down on married couples who set up companies based around one spouse’s work after HM Revenue & Customs lost a landmark House of Lords decision in July.

The decision, known as the Arctic Systems case, centred on a husband-and-wife business. The couple split ownership between them and received equal share of the profits as dividends. However, the wife, who merely undertook administrative duties, was paid a lower salary and paid less income tax.

Mr Darling said that draft legislation would be introduced “shortly” and would come into force in 2008-09. HMRC will apply a test to companies and partnerships to ensure that shareholders and partners are receiving a share of the profits that reflects their input into the company.

Mr Darling said: “Relevant factors to consider when establishing whether or not income shifting has taken place could include the work done by the individuals in the business, the investments made and the risks to which they are subject through the business.

“The Government believes it is unfair for one person to arrange their affairs so that their income is diverted to a second person, subject to a lower tax rate, to obtain a tax advantage, [that is] income-shifting. The vast majority of individuals cannot shift their income and income-shifting runs counter to the principle of independent taxation.”

Alex Henderson, tax partner at PricewaterhouseCoopers, said that legislation, would be a blow for family businesses and partnerships, including nonspouse couples. “There are rules to determine how much income you are allowed to take. This doesn’t just reverse the House of Lords decision, it will have a broader effect across the economy. For example, professional partnerships will have restrictions on how profits can be paid out. It’s clearly a significant tax-raising measure. People decide commercially how they will be remunerated. The Chancellor shouldn’t be meddling in this.”

John Brazier, managing director of Professional Contractors Group, said that income-shifting was “the natural consequence of independent taxation and was foreseen and accepted when independent taxation was introduced. Nothing has changed that should suddenly make it unacceptable.”

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