HMRC Refuses To Admit Defeat In Arctic Systems Case

by Robert Lee, Tax-News.com, London

17 January 2006

It has emerged that HM Revenue and Customs intends to seek a review of the recent decision by the Court of Appeal in a key test case involving Section 660A settlements legislation, leaving many thousands of small businesses in the UK continuing to face an uncertain tax future.

In an announcement made late on Friday, HMRC indicated that it will petition the House of Lords directly to seek leave to appeal, despite the fact the Court of Appeal refused the taxman the right to challenge its judgment in the Lords.

According to HMRC, Geoff and Diana Jones, owners of Arctic Systems, a small IT consulting company, had sought to illegally reduce their tax bill by allocating income and dividends to the less active partner in the business to take advantage of their tax allowance and lower tax rate.

However, overturning an earlier ruling by the High Court, a three member Court of Appeal panel ruled last December that the tax department had pushed its interpretation of the law too far, and stated that the couple's remuneration arrangements did not constitute pre-planned tax avoidance.

HMRC's apparent determination not let the issue rest angered the Professional Contractors Group, which helped the Joneses fund their legal battle.

According to PCG chairman Dr Simon Juden, HMRC's decision to petition the Lords will leave hundreds of thousands of small businesses in the UK facing an uncertain future regarding tax.

"The unanimous verdict of three of the most senior judges in the land was that, given that the Joneses shared the burdens and hard work of running their business, they were both entitled to share in the reward," Dr Juden observed.

"Appealing to the House of Lords will exacerbate and prolong the uncertainty caused by HMRC’s initial attempt to move the goalposts by changing their interpretation of 1930s legislation and announcing that they were doing so only after the fact,” he added.

Pointing to the judges' decision, Dr Juden argued that "the honest way to proceed" would be for the government to "legislate openly and clearly".

James Kessler QC, the leading tax barrister who has helped PCG fund the case, believes that the Revenue is not only being unfair to small businesses, but that it is also wrong in law.

Mr Jones generated GBP91,000 in fees in the tax year investigated by the Inland Revenue, paying himself around GBP7,000 in salary while his wife received around GBP4,000 in salary. The rest, after expenses and corporation tax had been subtracted, was distributed as a dividend split between himself and his wife, who owned a half share in the company.

“They are asking people to value the contribution of their spouse,” Mr Kessler noted.

“That is an almost impossible exercise and will vary from year to year, depending on individual circumstances. As a tax lawyer, I want to see the tax system operated in a way that is right in law, and fair and workable in practice," he added.

In the light of HMRC's decision to continue pursuing the case, tax experts are advising small businesses to follow the Court of Appeal ruling.

"The best advice is to go by the Court of Appeal judgment. That is the law of the land," John Whiting, tax partner at PricewaterhouseCoopers told BBC Radio 4's Money Box programme.

However, he urged businesses to keep extra money in reserve in the event that the Revenue should finally triumph.

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