Over the last few years, the tax matter that has attracted most attention and debate within the profession (and, at times, in the national press) is the goverment's ongoing attempts to attack businesses where profits are shared between two spouses, so that both spouses get to use their personal allowance and basic rate tax band. This attack has been focussed on the Arctic Systems case. Arctic Systems Limited was owned 50/50 by a husband and wife, Mr and Mrs Jones. Mr Jones did most of the work, but the dividends were paid to Mr and Mrs Jones equally. Setting up a company like this has been considered best practice for many years. HMRC tried to use the old "settlements" legislation to make all dividends paid by Arctic Systems Limited taxable on Mr Jones entirely. This would have collected about another £7,000 of tax a year, by denying Mrs Jones the use of her personal allowance and basic rate band. HMRC failed. The legislation had never been intended for that purpose, and the Joneses and their advisers won a comprehensive victory.
But everyone knew that the government would not rest there, and they have not. They have produced new draft legislation aimed at shutting down what they are now calling "Income Shifting" - the arrangement of a couple's financial affairs so that some income generated by work done by one of them is taxed on the other.
This legislation is now in a consultation phase. However, in Treasury/Gordon Brown-speak, "consultation" means "this is what we are going to do, but we want to be able to claim that we consulted on it". The consultation closes on 28 February, and the legislation will come into effect from 6 April, so there is clearly no time for any substantial changes to be made to it.
The new legislation is drawn very broadly, and almost any "husband and wife" business is at risk of being caught by it, unless it can demonstrate that the split of shares (or partnership profits) actually reflects the input that both/all parties have into the running and profit generation of the business. In fact, it has been drawn deliberately vaguely, but is to be accompanied by detailed HMRC guidance on their interpretation of it.
The problem with this approach is that it will take years before people have certainty about how they can plan their affairs. The nature of self-assessment is that you take a position on what your tax bill should be, and it is up to HMRC to disagree if they wish. HMRC pick some, and then you have a long sequence of commissioners' hearings, appeals and counter-appeals. All the time, other taxpayers are trying to best judge what the current interpretation of the legislation is, together with the general opinion on HMRC's chances of enforcing their view. How can taxpayers plan on that basis?
We've been in a similar situation before with IR35. In the case of IR35, HMRC sought to shut down "disguised employment" - a taxpayer, often a computer contractor, leaving a job on Friday, but coming back on Monday, sitting in the same desk, doing the same work, but this time invoicing via a limited company to save tax. IR35 effectively required people in that situation to put their hands up and voluntarily pay extra tax. In reality, almost nobody in that category put their hand up, judging a) that there was enough uncertainty in the rules that they could argue the toss if necessary, and b) that HMRC did not in any case have the resources to identify every such business. 99% of contractors chose to take the risk, on the basis that they probably would not be picked out and that they might be able to win the argument anyway. They were right. Almost none of them were picked out, and of those who HMRC did take on, almost none of them lost. IR35 was an utter failure.
So, will that happen here? I've no idea. Those contractors who decided at the outset of IR35 to put their hands up and pay the extra tax did it to achieve certainty about their tax bills. As it turned out, was that a good idea? Bluntly, in most cases, no. They have seen their colleagues have a dip at getting away without paying the tax, and all of those colleagues will have got away with it. The honest ones could be forgiven for feeling pretty aggrieved. if they decided this time to see if they could get away without putting their hands up, I wouldn't blame them.
Watch this space.
http://www.fizzhq.com
PS The new rules will not apply to salaries. In theory, you'd still be
able to pay a big salary to a spouse in order to use their tax
allowances, albeit taking a hit on National Insurance. But you'd have
to be careful - if the salary doesn't reflect work actually done, you
might not get corporation tax relief for it. And if the salary does
reflect work actually done, you're probably not caught by the rules in
any case and will be OK to just pay dividends! So although I've seen
one or two commentators saying you should pay the spouse salary rather
than dividend, I'm not sure that it'll work.