Darling to grab contractors' dividends

Alistair Darling yesterday extended his predecessor's brazen raid on 'micro businesses' by vowing new legislation will hit joint-owners who split their incomes to ease the tax burden.

In his first Pre-Budget Report, the chancellor said the "tax advantage" they currently obtain by diverting income to the owner who is subject to lower tax will be removed by April next year.

The fresh legislation, which industry will consult upon, will only apply when the income is in the form of dividends or partnership profits, the Treasury said in accompanying statements.

To establish "income shifting," the legislation might need to consider the work done by the individuals in the firm, the investments made and the risks the business subjects them to.

It is aimed squarely at 'husband and wife' firms, like IT contractor companyt Arctic Systems Ltd , which, like tens of thousands of other businesses, drew payment by income shifting.

Lawyers for HM Revenue & Customs spent four years, in vain, trying to persuade judges that Geoff and Diana Jones, the company's owners, avoided tax in this way and so broke the law.

Little wonder then that the government still insists it is "unfair for one person to arrange their affairs so that their income is diverted to a second person…to obtain a tax advantage."

The Professional Contractors Group, the trade body for contractors, which supported Arctic Systems in its fight, condemned Mr Darling for changing accepted tax planning at a whim.

John Brazier, its managing director said: "We did see this attack coming. The Joneses and many others like them were and are playing by the rules.

"The Chancellor now appears not to like the rules and wants to change them, which will make life much more difficult for people. In the process, this will stifle a lot of enthusiasm for business."

And though the PCG believes it is fair to assume the Arctic Systems case is the trigger for the legislation, it is unknown if the laws will apply only to 'husband and wife companies.'

Mr Brazier told CUK: "It is difficult to tell if this is necessarily a wider attack on business owners who source their income by drawing dividends.

"But certainly for micro business, husband and wife firms or anybody who has a joint business, the potential is quite terrible."

Based on the government's approach to micro business, PCG said all firms should now account for every single piece of work they do until it is certain how the legislation will apply.

"I think everyone [in a jointly-owned business] has to be very, very guarded over the next few months to make sure they are handling their affairs in the most professional way; nobody wants to be caught out," Mr Brazier said.

Kate Cottrell, founder of Bauer & Cottrell, a legal advisor to contractors, said detail on the legislation's scope will emerge in the consultation, which the PCG and ICAEW welcomed.

"I [also] await detail on…how it is going to be possible to establish the amount of work done by the individual and especially in a typical husband and wife partnership."

She added: "There is little time allowed for the consultation process and once again, we have a situation of uncertainty over the structures and tax affairs for genuine businesses."

Sharing concern about the framing of the law, Frank Haskew, head of the tax faculty at the ICAEW, said: "Whilst we understand the government's concerns in this area following the Arctic Systems case, we are not convinced that income splitting is workable in practice.

"We welcome the decision to consult but think that a more considered response is required."

And speaking before the PBR, Anne Redston, of the CIOT, who has advised Arctic Systems, warned any new rules for husband and wife companies would be difficult to draw up.

Speaking to CUK, Ms Redston said any new legislation would have to specify how many hours a spouse works in the business and state whether working in IT would have different tax implications to working in other areas, like administration.

At the time, she said: "If HMRC bring in new rules, they will have to look at the question of which husband and wife businesses are they really going to attack, and on what grounds, and what evidence are they going to need?"

Similar concern came yesterday from the PCG. Mr Brazier warned: "If the legislation dictates that activities of a company, or activities of two individuals within a company, have to be defined to the nth degree…then it will be incredibly complex."

"You could end up in a situation where each party, in the case of a husband or wife, would have to define precisely what they do for the business, and how they derive value for the business from that activity.

"What happens if one person in the business stays at home and does the administration [as Mrs Jones did] for the business, isn't that a value? It must be."

Roger Sinclair, legal consultant at Egos Ltd, believes the government's decision to legislate against what it deems 'income shifting' from as soon as next year is an audacious one.

He told CUK: "They haven't consulted yet, they haven't drafted legislation yet, and they still intend to bring it in with effect from April 2008."

For Simon Dolan, managing director of SJD Accountancy, Mr Darling's first PBR was "full of lots of talk and little concrete action."

The only relevance to all IT contractors was the chancellor's decision to scrap taper relief on capital gains tax and replace it with a single CGT rate of 18 per cent, he said last night.

"This effectively closes a loophole which was used by contractors when closing a company," Mr Dolan said, suggesting contractors who wish to avoid hefty tax bills should close their companies before the change takes effect from April next year.

Bernard Sweet, director of corporate tax at Chiltern, believes the single 18% levy will damage the prosperity of the self-employed.

He added: "This will strike far beyond private equity. Many smaller companies, their staff and investors will suffer as this relief is withdrawn. This could backfire on the government - it is a blow to hard-working entrepreneurs."

Advisors last night agreed the PBR's most positive aspect seemed to be the chancellor's decision to announce reviews into how tax can be paid more simply.

Mr Darling said: "I am announcing three reviews proposing simplification to the tax system that will let three million self-employed people pay their tax and National Insurance contributions more easily and 500,000 businesses reduce their paperwork by removing a separate payroll.

"Taken together with other measures I am proposing today, this will save British business up to £100 million a year."

But despite being welcome, some experts say these measures are too little too late.

John Cullinane, chairman of the corporate taxes sub-committee at the Chartered Institute of Taxation, told CUK: "The CIOT welcomes the continued commitment to simplification by the chancellor.

"This shows that Alistair Darling has been given real authority by the prime minister, contrary to the expectations of many. But it has taken many years to get an over complex system and it will take sustained effort, for a long time, to simplify it."

The sub-committee is likely to endorse Darling's pledge of lower corporation tax for big business, which will be cut by 2p to 28p next year, "the lowest in the G7" he reminded the House of Commons.

Yet not even the CBI got too excited about this recycled tax pledge.

In a statement, the UK's largest employers' organisation reflected: "Analysis shows that despite the welcome cut in the headline rate of corporation tax due to take effect from next April, announcements in this year's Budget will actually increase the overall tax burden on business by £1.6bn next year.

"This will bring the rise in the annual business tax bill purely as a result of policy change since 1997 to at least £10bn."

In its submission to the Treasury, the CBI called for corporation tax on small companies (with profits under £300,000) to be frozen, after Gordon Brown hiked it in his last Budget before becoming prime minister .

"The CBI was hoping for a statement for enterprise with encouragement for small businesses, which were hit by tax increases in the last Budget," said John Cridland, its deputy director-general.

"There was no such statement," he added, "and many small businesses will be hit again by the increase in the capital gains tax rate."