Hundreds of thousands of small businesses and family partnerships will be forced to pay more tax under reforms proposed by the Government today.

The crackdown on "income-splitting" arrangements will target husband-and-wife companies where one spouse performs the main service and the other has a lower paid, support role.

The changes follow a victory by husband-and-wife team Geoff and Diana Jones, who won their four-year battle against the taxman at the House of Lords yesterday.

The Jones’ landmark challenge against paying more tax came to be known as the Arctic Systems case, after the IT consultancy they jointly own and run.

The House of Lords confirmed that spouses are entitled to divide the profits of the company, paid in dividends, equally between them, irrespective of their unequal salaries and workload.

Tthe Lords also sanctioned the commonly used arrangement whereby one spouse pays tax on the dividends at a higher rate while the lower-paid spouse minimises their combined tax bill by paying tax at their lower rate.

However, under changes foreshadowed by Angela Eagle, the Exchequer Secretary to the Treasury, today, this practice will be banned.

Instead, the lower-earning spouse will pay tax on the dividends at the tax rate paid by the higher-earning spouse.

Ms Eagle told Parliament: "The [Arctic Systems] 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’."

"Some individuals use non commercial arrangements (arrangements that they would not reasonably enter into with an arms-length third party) to divert income (which would, in the absence of those arrangements have flowed to them) to others."

"That minimises their tax liability, and results in an unfair outcome, increasing the tax burden on other tax payers and putting businesses that compete with these individuals at a competitive disadvantage."

Ms Eagle said: "It is the Government’s view that individuals involved in these arrangements should pay tax on what is, in substance, their own income."

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