Chartered Accountants of Poynton, Cheshire

Following the recent House of Lords case, known as Arctic Systems, the government has decided to take action to tighten the tax laws that affect owner-managed business.

This may affect many owner-managed businesses involving husbands and wives and other family members. In the Arctic Systems case, HM Revenue and Customs (HMRC) alleged that Mr and Mrs Jones, the shareholders of Arctic Systems Ltd, arranged their business to minimise their tax liabilities by transferring income from the husband to the wife.

HMRC lost this case since it was held Mr and Mrs Jones had not acted to deliberately manipulate their tax affairs. The government strongly disagreed with this decision and have decided to change the rules in HMRC's favour.

This is a very contentious area of taxation and will go through amendments as the law develops. The government indicated in late 2007 their preferred model for taxing owner-managed businesses.

Who is affected?

The government is targeting businesses run by a husband and wife, and this includes civil partnerships. It could even extend to other family members involved in the business. The government wishes to avoid what it calls 'income shifting'. In other words, say there is a small business that generates profits of £70,000. If all of this was allocated to one of the spouses, it would attract tax not only at the basic rate but also the higher rate of 40%. If the spouses allocate, say £35,000 to each of them, this can reduce or even eliminate the tax due at 40%.

The government wants to stop this 'income shifting' but it has a problem in that, in many small businesses, both spouses work equally in a business and the allocation of profits fairly reflects the work done. In some cases, only one of the spouses works in the business but the non-working spouse is allocated significant profits.

What the rules say

To address this, the government has suggested a range of highly subjective conditions to determine the allocation of profits. But, herein lies the problem - the tests are so subjective that it is very difficult to work out how they apply.

What is affected

The new rules apply to the profits from a trade, and dividends from a limited company. hey might also be applied to rental income from properties. The government also wants to have a retrospective element to the new rules, so that they could be applied to past years.

What to do next

The changes to these rules will develop over the coming months. If you have a business that falls into this category, we will be pleased to advise you on how this legislation might affect you and your possible options. It is important to plan for the changes, make sure you comply with the new regulations, and plan for higher tax bills that might fall due for some owner-managed businesses.