For Geoff and Diana Jones and their company Arctic Systems, the long-running battle with the taxman over how the couple advantageously split the spoils of the business is over.

But for the government, advisers and businesses in a similar position to the Joneses, the fun has only just begun. The five Law Lords unanimously threw out HM Revenue & Customs’ challenge to the Joneses’ business structure.

Put simply, Mrs Jones owned half of the company, while Mr Jones carried out the main thrust of its IT work. The government said the structure was a ‘settlement’, a term denoting that a tax arrangement had been put in place with the aim of giving a ‘bounty’ to his wife.

If she had not been his wife and at ‘arm’s length’ in her relation to him, the set-up would not have existed and thus could be set aside for tax purposes, HMRC argued.

The upshot of the House of Lords judgment was that, even though it agreed there was a settlement, there was an exemption under the rules for ‘gifts’ between one spouse and another, which this fell into.

The result was widely welcomed by advisers and representatives of the small business community, even if the result related only to husband and wife businesses.

‘The CIoT is delighted that, after such a long battle, the Lords has confirmed that HMRC were wrong to attack husband and wife businesses in this manner,’ said CIoT fellow Anne Redston.

Further criticism of HMRC also followed the Lords outcome. Questions were raised as to why the taxman had not treated the battle as a test case and covered the Joneses’ costs, which were picked up by the Professional Contractors’ Group.

Others suggested that the verdict had been widely anticipated. ‘The outcome raises questions about why HMRC decided to contest the case in the first place and create enormous uncertainty for several years as the legal process was unravelling,’ said Ernst & Young tax partner Patrick Stevens.

‘Even if there was some doubt about the correct interpretation of the law, it had not been challenged by HMRC for many years. It may have been far simpler for HMRC to change the legislation, if that was the desired result.’

But despite advisers warning the government against a ‘knee-jerk reaction’ to the outcome, the Treasury has already announced that it will introduce new tax legislation in the next finance bill to stop ‘unfair’ income-splitting arrangements by some family businesses.

‘It is the government’s view that individuals involved in these arrangements should pay tax on what is, in substance, their own income and that the legislation should clearly provide for this,’ the Treasury said.

Grant Thornton senior tax partner Mike Warburton had thought the government would hold off announcing what would amount to a clampdown on small business. ‘If they removed the exemption it would be done at significant political cost,’ he said. ‘[The government] would be saying there should be a tax on hard-working couples’ businesses.’

But a clampdown, it appears, is on the cards. Geoff Jones believes it would have been sensible for the government to ‘take some time’ over its decision and consult to reach an agreement with all parties.

‘It makes them look like sore losers,’ said Jones. ‘It’s a recipe for future conflict, where do you draw the line? We need to know where the line is.’

It is difficult to know precisely where the Treasury will draw the line. Its description of income-splitting structures could apply to a huge number of common tax planning arrangements.

Redston agrees that it will be difficult to distinguish between ordinary family businesses and those that the government believes abuse the system. The arguments will no doubt continue up to the next finance bill, and beyond.

HMRC’s swift revenge

The government’s reaction to HM Revenue & Customs losing the Arctic Systems case has been swift.

The Treasury said that it would introduce legislation to stop ‘unfair’ income-splitting arrangements by some family businesses.

When couples enter into a business agreement that they would not normally do with someone else, to minimise their tax liability, then it results in an ‘unfair outcome’ that increases the tax burden on other taxpayers, the Treasury said.

‘The government will therefore bring forward proposals for changes to legislation to ensure this is the case. In the meantime, HMRC will apply the law as elucidated by the House of Lords and will be providing guidance in due course.’