Family firms' tax law 'poorly framed'

Tax and legal advisors are condemning the sloppy framing of new rules that quash a decades' old practice 'husband and wife' firms have used to lower their tax bills.

The Treasury proposes to stop business owners paying less tax by shifting part of their income to a co-owner, spouse or family member who is subject to a lower tax rate.

Most famously this practice was used by Geoff and Diana Jones, owners of IT contractor company Arctic Systems, and subsequently endorsed by the House of Lords.

But the government refused to accept this ruling, saying Mr Jones had deliberately lowered his earnings so that Mrs Jones could get some of that income as dividends.

It now says that someone in a company or partnership who passes their income, as dividends or partnership profits, to a "connected" person just because that person pays a lower rate of tax is "unfair."

This appears to be based on assertions from HM Revenue & Customs that the majority of individuals – all employees and most business owners – cannot shift their income.

As a result, legislation to take effect from April 6 will apply to business owners who split dividends or profits so as to move income from a higher to a lower rate taxpayer.

As currently drafted, the legislation will end income splitting where the spouse or partner "plays either no role or only a minimal role in the business".

The UK's leading accountancy body, the ICAEW said: "We regret, however, that many commercial arrangements may also be caught because the proposals are very widely drafted.

"They will catch many owner-managed businesses involving husbands and wives and other family members. The difficulty will be working out whether they are caught by the definition or not.

"This will lead to yet more uncertainty for many entrepreneurs, who are likely to have to spend much more time looking over their shoulders to see if HMRC will attack their structure."

In line with one legal expert's view that the draft rules depart from "commercial reality" , the ICAEW believes they fail to take account of "the real complexities" of most affected businesses.

Francesca Lagerberg, of the group's Tax Faculty, added: "Many spouses do not have formal meetings to discuss their business arrangements, they just have their own way of working together.

"Owner-managers will need to try and establish whether their existing dividend or profit allocation is still acceptable and for many businesses this will be no easy task."

The Institute of Directors has welcomed the draft legislation, in principle, but agreed with the consensus that it must be made more specific for it to meet the government's intentions.

"These expressions are hopelessly vague," the IoD said in a statement, referring to the government's proposed criteria that would mean the legislation applies.

Richard Baron, the group's head of tax, added: "The government has a perfect right to ask parliament to change the law.

"But it should not propose legislation like this, which will be wholly impractical as it stands."

Colin Howell, director of No Longer Limited, says the draft legislation has "always been in the pipeline", particularly since s660A emerged as insufficient in stopping all cases of income shifting.

"If the business is genuine then the business owners should have nothing to worry about," he said.

The tag of "genuine" shifts the problem onto new ground: what actually constitutes a 'genuine' business.

One legal advisor, Roger Sinclair, consultant at Egos raised the concern: "I'm not so sure that Mr & Mrs Jones of Arctic Systems would wholly accept the statement 'if the business is genuine then the business owners should have nothing to worry about'.

Meanwhile, the ICAEW is calling on businesses to review the
HMRC/Treasury consultation document , and to respond to its questions before the legislation is finalised.

Ms Lagerberg said: "The more practical examples that HMRC receive, which show where this will cause real difficulty, the better the chance of change.

"If HMRC wants to make this work it will need to consider offering some form of clearance procedure to help taxpayers work out where they stand."

The institute added: "We are very disappointed that this is yet another instance where relatively brief legislation is being supplemented by lengthy HMRC guidance, which has no place in law."

Dec 12, 2007

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