HUSBAND-AND-WIFE businesses face the prospect of a huge increase in the amount of paperwork needed to complete their tax returns, after a landmark ruling in the House of Lords, according to tax experts.
Small-business organisations were initially delighted when the Lords last week ruled in favour of Geoff and Diana Jones, co-owners of Arctic Systems, an IT consultancy in West Sussex, who used an income-splitting arrangement to minimise their tax.
The Joneses’ victory, which followed a four-year battle with HM Revenue and Customs (HMRC), is good news for other husband-and-wife businesses that faced the prospect of being hit with retrospective taxes. The judgment draws a line under the case.
However, the Treasury’s subsequent announcement that it plans to change the law in the light of the ruling has left similar companies nursing a pyrrhic victory and facing the prospect of yet more confusion and red tape.
Tax experts warned that as part of its review, the government was likely to abolish the exemption that allows husbands and wives to make each other an outright gift.
Mike Warburton, tax partner at Grant Thornton, said: “If they remove the exemption, people who set up businesses where a husband and wife each own part of it cannot assume the dividends they receive should be taxed only on their own return.
“That means they are going to have to work out whether some of the dividends that have been paid out should be taxed on their partner’s tax return. It is going to be extremely complicated.”
He said that while small businesses that used accountants to complete their tax returns would be able to ask them to do the calculations on their behalf, those small firms that used self-assess-ment would be left completely in the dark.
He said: “They are going to be forced to submit an enormous amount of additional information on their personal tax return to make sure they fulfil their obligations to the Revenue.
“Instead of simply putting the amount of dividends they have received, to be safe they will probably need to submit their company accounts, information about what each of them does in the business, of how many hours they work in the business, and what the market rate for their job would be.
“It is going to be incredibly complicated and will create a massive burden of red tape on the smallest businesses in the country.”
Emily Campbell, a barrister at the Wilberforce Chambers, which acted for HMRC in the Arctic Systems case, said: “It is good news for small companies in the short term, but I suspect it is a pyrrhic victory for future tax years.”
Stephen Alambritis of the Federation of Small Businesses, which represents thousands of husband-and-wife firms, called on the government to drop its plan for a review.
“The House of Lords decision is a good morale booster to 300,000 family businesses, but the threat by the government to override the decision and introduce legislation is a real worry that will increase uncertainty about how family businesses undertake their tax affairs,” he said.
“We believe it would be mealy-mouthed and curmudgeonly of them to hold a review. The government has bigger fish to catch rather than trying to come down hard on small, family businesses.”
Geoff and Diana Jones were originally taken to court by HMRC four years ago over a £25,767 dividend payment made to Diana during the 1999-2000 tax year.
The couple had arranged their tax affairs so that both held shares in the company and received similar dividend payments, but Geoff Jones was identified as generating the greater income while his wife was deemed to have earned less because all she did was tend the administrative side of the business. The Revenue argued that he had unfairly transferred some of his income in the form of the dividends to his wife to benefit from her lower tax status.
Announcing its review of the tax system, the Treasury said in a statement: “This case has brought to light the need for the government to ensure that there is greater clarity in the law regarding its position on the tax treatment of ‘income-splitting’.
“It is the government’s view that individuals involved in these arrangements should pay tax on what is, in substance, their own income and that the legislation should clearly provide for this.”
Tax experts called for the Treasury to tread carefully when introducing new legislation aimed at small business.
Leonie Kerswill, tax partner at Price Waterhouse Coopers, said: “If the government introduces new legislation in this area it needs full and careful consultation and the result should be clear legislation that is simple to use so that small businesses of this type are able to plan and manage their tax affairs correctly and effectively.”
Peter Penneycard, partner and director of tax at the accountancy firm PKF, said: “We welcome the Lords’ decision, but clearly HMRC is not going to let the matter rest there. HMRC’s next move is likely to be a push for changes to legislation to prevent all small-company owners using what is a long-standing practice to their advantage. Unfortunately, while HMRC may increase its tax take, this is likely to make starting a new business less attractive and damage entre-preneurial spirit within the UK.”
He said a review should cover income tax, corporation tax, National Insurance contributions and dividends.
He added: “Unfortunately, HMRC has shied away from this complex task. If it now goes for a quick fix by fiddling with the rules [on transferring income to someone else], the root cause of the problem will remain – namely that the tax regime of limited companies and sole traders is a mess.”
