Ruling may complicate tax system

Oct 08, 2007

HUSBAND-AND-WIFE businesses across the region face a potential avalanche of red tape needed to complete their annual tax returns following the conclusion of a landmark case in the House of Lords earlier this year.

Initially, the flags were out for owner managers when the lawmakers ruled in favour of Geoff and Diana Jones, co-owners of Arctic Systems, an information technology consultancy in West Sussex, who used an income-splitting arrangement to minimise their tax.

Geoff and Diana were originally taken to court by HM Revenue & Customs four years ago over a dividend of £25,767 which had been paid to Diana in the tax year 1999-2000. It had been judged that Geoff had used dividend payments to his wife as a means of reducing his income tax liability.

Such a division of dividends had been viewed by Arctic Systems, as well as by thousands of other businesses across the UK, as a tax-efficient way for a spouse who is not a 40 per cent taxpayer and who works far lesser hours in the business, if at all, to make use of the annual tax-free personal allowance and lower rates of tax. The income that is received is paid out as a dividend and is not taxed at the main earner’s marginal rate of tax.

The reason that HMRC objected so strongly to this is that it claimed that such individuals were avoiding tax. In essence, the taxman believed that the owner-manager was effectively passing on the profits of the business to his or her spouse to reduce taxable income.

Now that the four-year battle with HMRC has reached its ultimate conclusion, the Jones’ win lifts the threat of retrospective taxes for other husband and wife businesses in a similar situation.

However, news that the Treasury intends to change the law in the light of the Lords’ ruling has left owner- managers with a somewhat pyrrhic victory. Any ensuing legal changes are likely to add to the current complications in our tax system and create more uncertainty for taxpayers.

This is where the likelihood of increased confusion as well as paperwork may arise.
For example, when completing personal tax return forms, husbands and wives in similar circumstances may have to consider the family company. In particular, they may need to look far more closely at the contribution each spouse makes to the business and the spread of rewards received.

If the rewards taken from the business in the form of a dividend do not match the contribution each spouse makes, then an adjustment may be required to their tax returns.

For further information please contact Judith Hooper on 01908 687800, email judith.hooper@bakertilly.co.uk or visit www.bakertilly.co.uk

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