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Entrepreneurs face further tax misery

Thursday, 06 December 2007

The reversal of the Arctic Systems court win will increase the tax take from the UK’s business heartland, experts have warned.

Business and financial adviser Grant Thornton says that the Government’s move to reverse the House of Lords' decision in Jones v Garnett and push ahead with new 'income shifting' rules will leave many entrepreneurs with higher tax bills and more complexity to contend with.

Jones v Garnett, which is better known as the Arctic Systems Ltd case, went to the House of Lords in July 2007. The husband and wife team of Mr and Mrs Jones successfully defeated HMRC's contention that the dividends received by Mrs Jones from their company should be reallocated to Mr Jones, a higher rate taxpayer, under the so-called settlements legislation.

In the House of Lords all five Law Lords found in favour of the taxpayer and rejected the appeal by HMRC. Mr and Mrs Jones were, however, exempt from the charging provisions due to the specific exemption available for certain transfers between married couples and civil partnerships.

Immediately after the verdict, the Government announced a change in the legislation. The new rules, which would come into effect from 6 April 2008, are detailed in a consultation paper issued on Thursday by Her Majesty's Revenue and Customs (HMRC).

Difficult pill to swallow

The raft of detailed legislation and guidance points will be a difficult pill to swallow for busy owner-operated companies who will find it difficult to understand whether they are potentially caught out by the moving tax rules.

Francesca Lagerberg, Head of the National Tax Office at Grant Thornton UK LLP, says she is struggling to see where the proposals on income shifting fit into HMRC’s promise to cut red tape and reduce complexity.

"The Government has pursued this issue with great force and the result must come as a bit of a shock to the taxpayer following the Arctic Systems win at the House of Lords in July," she says.

"As a result, the Government has changed the law to target what it perceives as unacceptable tax avoidance, but the difficulty is going to be separating out those it wants to catch from those it does not. Many entrepreneurs will now develop a persecution complex as the tax rules change yet again for them,” said Lagerberg.

The new rules are to stop individuals transferring income between each other in a tax-advantageous way. In particular, HMRC is looking to catch the type of situation where a 40 per cent taxpaying spouse runs a business and their lower rate taxpaying spouse does little or no work but takes at least half the dividend from the company or half the profits from the partnership.

Commercial

It is not just married couples that will be caught out by the new rules either as the proposals are potentially aimed at any situation where an individual would not enter into a transaction on the aforementioned basis if he or she were acting commercially.

"The crunch term here is what is 'commercial,'" says Lagerberg. "Taxpayers and their advisers will need to examine the examples in the consultation paper to see if they are to be caught or not. The likelihood is that their situation won't quite replicate anything they see in the consultation paper and they will remain confused as to whether they have a problem or not."

Lagerberg notes that the proposals coming out on top of the recent capital gains tax changes mean yet another hit on small business owners.

“Additionally, small companies are already facing another uplift in their tax rate from next April when the charge rises to 21 per cent, so the risk of a further hike in their tax bill due to income shifting will be hard to stomach,” she concludes.

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