Tax is more than just a family affair

10 August, 2007
Husband-and-wife businesses need to keep abreast of their tax affairs as a recent case questioning the rules on settlement has put the issue under review, says John Whiting
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Small businesses can thank the House of Lords for guidance on how to organise their tax affairs, following a decision in the case of Arctic Systems.
The Jones vs Garnett (Arctic Systems) case concerns the tax treatment of a husband-and-wife-owned company, with HM Reve-nue & Customs (HMRC) believing that unacceptable arrangements had been made in order to reduce the overall tax liability of the husband and wife concerned.The company, equally owned by Geoff and Diana Jones, had a turnover of £91,000 for one particular year, derived from Mr Jones' activities. He drew a salary of £7,000, while his wife drew a salary for administrative work of £4,000, for which she worked about four hours per week. After expenses and corporation tax, the couple shared the remaining £60,000 equally in dividends. As a consequence, the pair paid less tax and national insurance contributions on their income, because they took dividends rather than salaries, and a significant portion went to Mrs Jones to use up her lower tax rates.HMRC's technical argument was that Mr Jones's actions in setting up the company, allowing his wife to subscribe for an ordinary share, and the general arrangements all constituted a 'settlement'. Under anti-avoidance rules, the income of a settlement can be treated as that of the settler in some cases. As far as husband and wife (or civil partners) are concerned, the settlement rules don't operate unless the property given is "wholly or substantially a right to income".Tax assessmentHMRC assessed Mr Jones on six years' worth of dividends paid to his wife by Arctic Systems, producing a tax bill of about £42,000 once interest had been added. What was at issue was the amount paid to Mr Jones: HMRC would have been happy if he had been paid a substantial salary by the company, leaving just a small profit to be paid out as dividends to the co-owners.One point worth noting is that companies with significant assets wouldn't be caught by this new approach. That's because when the shares in the company were allocated, even if the husband was making a settlement, it wouldn't be just a gift of income but would involve the assets owned by the company as well.There were three issues with the HMRC stance:? that an ordinary share doesn't just give a right to income? how can taxpayers accurately assess the right amount of income? ? this was a change of stance from HMRC, challenging a long-standing arrangement.The Jones' first appeal produced a finding in favour of HMRC and this was upheld at the High Court. However, the Court of ­Appeal found for the Joneses.The House of Lords has upheld the Court of Appeal, saying there was a settlement, but agreeing that it wasn't just about income. The arrangement fell into the exception in the settlement rules.One of HMRC's contentions was that it has regularly taken similar cases and settled with taxpayers. Those taxpayers may well be due a repayment and should be talking to their tax advisers.However, the government has already announced that it will change the law to reverse the House of Lords' decision. Exactly how and when (probably next April) remains to be seen, but husband-and-wife businesses will have to keep their taxes under review. nJohn Whiting is a member of the Chartered Institute of Taxation



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