ARCTIC SYSTEMS
THE FUTURE FOR FAMILY OWNED SERVICE COMPANIES
It has been reported previously in Enterprise Express that on the 25th July 2007 the House of Lords gave its judgment in the case of Jones v Garnett (also known as “Arctic Systems Ltd”). The Revenue had previously lost this case in the Court of Appeal and as a result had appealed to the House of Lords.
The case concerned dividends payments made by Arctic Systems a company owned by Mr and Mrs Jones to Mrs Jones. The company’s business was to provide IT consultancy services to third parties but only Mr Jones provided those services on behalf of the company. The Revenue took the view that the settlements legislation (section 660A et seq of the Income and Corporation Taxes Act 1988) applied. They therefore sought to tax the dividends received by Mrs Jones as Mr Jones’ income. Due to the application of higher rate tax, this resulted in a substantially higher assessment against Mr Jones than the assessment in aggregate for Mr and Mrs Jones.
In response to the Arctic Systems case a consultation document aimed at ending income splitting was published on the 6th December 2007. The 44 page consultation document contains far ranging draft anti-avoidance legislation that will take effect for the tax year 2008/9 and following tax years i.e. from 6th April 2008. The draft legislation reflects the view that there should be greater ‘clarity’ in relation to income splitting and seeks to ensure that individuals involved in income splitting arrangements should pay tax on what is, in substance, their own income.
The legislation is not particularly well drafted and leaves more questions than answers but combined with the accompanying draft guidance it leaves the writer in little doubt that the Revenue mandate is to seek to assess as the income of the working spouse, company dividends going to both spouses where only one spouse works in the business and has not contributed substantial capital (and even in that case there is some doubt). It will undoubtedly lead to some unfairness, particularly where a spouse has worked in a business previously and to many costly Revenue enquiries. The only ray of light is that thankfully the legislation looks like it will not have retrospective effect as was first thought might be the case.
However it does leave a lot of family businesses with a dilemma going forward as to whether to undo existing arrangements. Whatever view you take going forward you may wish to consider whether it is possible to bring forward the declaration of a dividend in your company to before the 5th April 2008 to fall outside the proposed legislation. There may still be advantages in keeping the arrangements or simply having a company rather than reverting to sole trader status, even if your company is clearly the target of such legislation: you may still save considerable national insurance (13.8%) by declaring dividends rather than paying salaries, you may wish to keep the company to stockpile surplus income at lower rates of corporation tax than apply to income tax, it may be that you have a good case for not falling foul of the legislation or can improve your case by having the non-working spouse make capital contributions to the business or it may be that you have some other viable means for extracting cash from the company without declaring dividends. The point is that unfortunately you will need to take detailed advice on the advantages and disadvantages of carrying on with such a company or a partnership. The advice will differ on a case by case basis because whether you fall within the legislation will differ depending on your own circumstances. No doubt also the prospect of a Revenue enquiry will hold different appeal to different people. Some people will wish to chance their arm whilst others will not want the hassle and expense.
If you think you are affected by this case or may be affected by the proposed legislation, we would strongly advise you to take advice now. Sandersons Solicitors are able to give advice and planning assistance on a wide variety of tax issues for businesses and individuals and we would be pleased to help.
If you wish to contact us please contact in the first instance Duncan Rann
Tel: 01482 324662
Fax: 01482 223110
e-mail: enquiries@sandersonssolicitors.co.uk
Source: The Federation of Small Businesses, November 2007