Inland Revenue Hits Small Businesses Trying To Reduce Tax Bills

by Jason Gorringe, Tax-News.com, London

13 March 2003

The UK Inland Revenue has begun to target small firms run by married couples in a bid to close what it deems to be a tax loophole and some are facing huge payments as a result.

A widely used practice by small family firms is to share the ownership of the company 50/50 between husband and wife with earnings being paid as part dividend and part salary. That way, the tax burden is reduced on the main earner who is liable for the tax bill.

However, the Revenue has now begun to challenge the way such firms operate, and is investigating each individual's contribution to the earnings of the company. In short, if the tax man thinks that you have not, in his eyes, made a sufficient contribution to the earnings of the firm to justify the dividend paid, then he will simply add this on to the income of the person who he thinks has done the most work. This has led to many firms' tax bills being re-adjusted, in many cases quite drastically.

"If you haven't done enough work to justify the shareholding split, then they could challenge you and reallocate the dividends to the main shareholder, typically the husband," said Anne Redston of accounting firm Ernst and Young, adding: "He would then have a bigger tax bill. It is however far from clear that the legislation allows them to do this in all the cases they are now taking up."

The Inland Revenue says that the statute book has allowed them to enact this procedure since 1936, though it seems that tax officials have only just begun to cotton on to the idea.

In the case of Geoff and Diana Jones from Pulborough in West Sussex, a re-assessment of their income led to the Inland Revenue demanding an extra £42,000 in unpaid taxes. "It was a total shock. My wife and I have always done everything straight down the line," Mr Jones, a computer contractor, told BBC News Online. "We set up our business in the same way that everyone does around the country - I feel like we've been singled out."

Though such cases are relatively rare at the moment, there appears to be an increase in the Revenue's interest in this somewhat grey area. Matt Boddington of Accountax told the news service: "It is certainly more prevalent than it was five years ago - even though the legislation has been around for a long time." Steve Greenwell of tax consultancy Qdos agreed, explaining that such demands are likely to hit small businesses hard: "It is very traumatic for people who find themselves in this position. The recalculation of tax liabilities can be quite substantial - and run into tens of thousands of pounds," he told the BBC.

In a statement relating to the matter the Inland Revenue said: "This is anti-avoidance legislation, which has been in place since 1936. It prevents avoidance of tax, for example, a taxpayer with a higher rate of tax transferring income to someone who is liable at a lower rate. The legislation (in relevant cases) treats the income as belonging to the person who transferred the income, rather than the recipient." The Revenue went on to deny it had "changed its policy or practice on this."

This is cold comfort for Mr and Mrs Jones however, who are considering taking their case to the Tax Commissioner, and if necessary, bracing themselves for a lengthy court battle. Mr. Jones said of the Inland Revenue's actions: "If they wanted to introduce something new or general across the board, then they should have announced it. Nobody was aware of this - not even the professionals."

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