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With this ring I thee tax

Scott Mcculloch is editor of Families in Business.

Family businesses face continued uncertainty over their tax affairs

Never has Britain's taxman been the source of so much pillow talk since a mild mannered Sussex couple were slapped with a stinging £42,000 tax bill. Their crime? They were a family business who shared their wealth.

The controversy concerns the Revenue's use of anti-avoidance legislation from the 1930s to crack down on companies where one spouse brings home most of the income but both share dividend payments equally.
 
For Geoff and Diana Jones it was all too much. Mr Jones is a computer specialist and the sole director of an IT company called Arctic Systems. Mrs Jones acted as company secretary and looked after the financial administration of the company. Each held one share in the company. Mr Jones paid himself a small salary and both received dividends from the company.
 
The Revenue concluded that, because most of the IT expertise was the contribution of Mr Jones and because he drew a modest salary, the share owned by Mrs Jones was "wholly or substantially a right to income".
 
The Professional Contractors Group (PCG) took up the Artic case. When the legal proceedings began last June, the Revenue dropped its claim for several years of back taxes, claiming only the tax for the most recent year.  Last September Geoff and Diana Jones stood in front of Revenue officials to contest a £6,000 bill (reduced from £42,000) they had been handed.
 
They lost. A special commissioners judgement backed by the Revenue concluded that the dividend payments did not accurately reflect the contributions made by the husband and wife. Until now, spouses have been able to pay themselves equal company dividends to take advantage of one partner being in a lower tax band, even if working responsibilities are shared unequally.

By November the Joneses, backed by the PCG, confirmed their intention to appeal the case in the High Court. Senior Revenue ministers are said to be quietly seething over the amount of attention the tax ruling has attracted. The legal victory for the Revenue indicated that officials could force companies run by husband-and-wife teams to pay extra tax if one partner contributed more work than his or her spouse to the business.

Small business ministers are being rebuked by accountants and campaigners for failing to clarify how family businesses are taxed. The ruling by special commissioners suggested that husbands and wives who draw dividends from family firms should be treated as if all the income is the husband's, preventing the wife from using her personal tax allowances.

Critics insist the Revenue's 49-page guide on dividend income falls short of clarifying the so-called husband and wife tax. An opaque sentence buried 14 pages into the guide attempts to defuse fears over how to apply the rule. "Take a step back and consider, 'If I was making these arrangements with an independent third party, would I pay them these wages or dividends or share my partnership profits in this way?' If the answer is no then the legislation probably applies."

The law, according to the Revenue, could affect at most 30,000 small business. The PCG, which believes as many as 200,000 business could be affected, begs to differ. "This guide fails to address the key elements of the vagueness surrounding this measure and does little to mitigate the uncertainty for small family business owners, who will no doubt be surprised to hear that they are not classified as an ordinary business," said Simon Juden, chairman. A High Court date for the case has been set for 15 March.

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