The Debate: Revenue’s approach to married couples

Policy change cripples couples

By Kevin Miller

The Inland Revenue appears to be adopting a new approach to the taxation of small companies run by married partners, which could cost taxpayers as much as £2bn in additional taxes and interest, and another £200m in additional professional fees.

The Inland Revenue has denied that there is a new approach, but many accountants and tax advisers have been surprised by the Revenue’s new attitude to Section 660 of the Income and Taxes Management Act 1988, and are disputing its basis in tax law.

The legislation was designed to prevent the transfer of income earning assets from a higher rate taxpayer to a lower rate taxpayer in order to avoid taxes. This legislation has a specific exemption for transfers between spouses, which the Revenue now argues does not apply in some cases.

As a recent case showed, the Revenue is applying this approach retrospectively – going back six years.

For one couple this has resulted in a tax demand for £42,000 (and rising).

For accountants this represents a tremendous threat to their professional indemnity insurance, given that the Revenue is arguing this is not a new approach and the law has been in place for years.

The Revenue now claims that the dividend income received by a spouse, especially those who may only be a part-time worker in a family company, can represent a bounty provided by the working spouse, who forgoes a reasonable salary in order to increase the profits of the company that are available to be distributed by way of dividend.

Section 660 potentially affects any type of profitable business owned by a husband and wife – be it a service company, a manufacturer, a retailer, a building company or other trade.

Apart from the costs in additional tax and professional fees, the uncertainty it creates will discourage new business startups. Something that would go against the government’s push to make Britain an entrepreneurial society.

  • Kevin Miller is a chartered accountant and IR35 expert.

Why not enforce existing rules?By Mark Lee

There are reports that the Revenue has identified a ‘new’ way to challenge the tax benefits that follow from the incorporation of sole trader businesses where shareholdings are divided between the spouses.

In a few cases it’s quite feasible that ‘settlements’, as defined by Section 660A of the Income and Taxes Management Act 1988, have been made.

But is it right to accuse the Revenue of an ‘unfair tax raid on small companies’ merely because inspectors have suggested that the settlements legislation may be in point?

I’m no apologist for the Revenue, but commentators and authors on incorporation have long highlighted the need to be conscious of the settlements legislation when sole traders incorporate and subsequently want to pay dividends to a spouse.

There are complaints that the Revenue should have announced it was going to ‘start’ looking to apply this legislation strictly. That’s certainly the approach the police adopt when they ‘start’ a campaign to enforce the speed limit.

I’m not sure it’s reasonable, however, to expect the Revenue to adopt the same tactic. Tax law is much more complex than the law imposing a specific speed limit. The point has long been addressed in what is now known as the Revenue’s trusts, settlements and estates manual.

Additionally, the issue as to whether or not the sole trader has made a settlement is not always easy to resolve. In many cases there will be a strong defence.

Of course, it’s all but impossible to ‘self assess’ a tax liability under this or any other anti-avoidance legislation. I believe we should treat the current scare as a wake-up call. Anyone with clients who may be affected by the alleged new approach needs to become familiar with the relevant legislation and the Revenue’s interpretation thereof.

You may also wish to check out informed guidance as to how best to avoid successful Revenue challenges as regards the tax efficiency of dividend receipts from small husband and wife companies.

  • Mark Lee is director of tax services at tax consultancy WJB Chiltern plc.

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