Court of Appeal verdict: Victory for family-run companies
“This is arguably the most important tax case of the last 20 years.”
David Smith of Accountax Consulting
16 12 2005 United Kingdom
In a landmark case the Court of Appeal has overruled an earlier High Court decision that the director of a small business should pay income tax on dividends paid to his wife by the company they owned jointly.
The Inland Revenue had claimed that this was 'avoiding tax' because the main earner of the company is giving income as a dividend to the spouse and demanded £42,000 in arrears of tax, interest and penalties.
This decision restores the position for ‘husband and wife’ companies so that the directors can arrange their remuneration from salaries and dividends and minimise their overall tax liabilities.
After a two-day hearing in November, the Court of Appeal gave a unanimous verdict in favour of the taxpayer, delivering a severe blow to HM Revenue and Customs. The court decided that the authorities were unjustified in attempting to extend the tax legislation to a business venture set up by a husband and wife.
This case has been embroiled in controversy ever since April 2003 when the Inland Revenue issued a formal warning that it would apply a provision in the Income and Corporation Taxes Act, 1988, where a husband and wife both own shares in their company and the husband is the main earner of income for the business.
The accountancy profession and representatives of small businesses protested strongly that the new interpretation of the Act breached the principle of the separate taxation for husbands and wives. But Treasury minister Rt Hon Dawn Primarolo MP refused to be moved.
The storm of outrage was fuelled in June 2004 by a tax decision concerning Geoff Jones, director of a small IT consulting business in Sussex. He set up Arctic Systems Ltd 13 years ago with his wife Diana, who assisted part-time with the company administration.
Mr Jones first appealed against the Tax Inspector’s decision that the higher rate of income tax should be paid on his wife’s dividends, as though they were his personal income. The appeal was made on grounds that dividends paid to his wife as shareholder were her income, not his, so the lower rate of income tax should apply.
However, he lost the first appeal due to a highly controversial ruling by Inland Revenue Special Commissioners.
The two Commissioners hearing his case reached different conclusions and it is accepted practice after a split decision for the verdict to be given in favour of the taxpayer. But in this case, without explanation, the presiding Commissioner exercised a casting vote to uphold the view of the Inland Revenue.
Supported by the Professional Contractors Group (PCG), members of the legal and accountancy professions, members of the public and organisations representing small businesses, Geoff and Diana Jones mounted an appeal to the High Court as a test case on behalf of other family-run companies.
Welcoming the Court of Appeal’s judgment, PCG chairman Simon Juden said, "This means proper recognition for the hundreds of thousands of people who choose to run their own businesses, share the burdens and the hard work with their partners, and rightly expect to share the profits of their efforts.
"We hope this marks the beginning of a fairer approach to tax on small businesses."
The Court of Appeal refused a request by HM Revenue and Customs for leave to appeal to the House of Lords. However there are indications that the Treasury intends to circumvent the court’s decision by introducing new legislation to enforce higher tax bills on the owners of 200,000 small companies and partnerships.
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You can find out more about S660A and the tax claim against this businessman in the Knowledge Centre – Taxation of the main earner in a small company or partnership (for topenterprise members)
Footnote
This article is intended to contribute to informed decisions by business owners, directors and managers. It does not constitute professional advice in all individual cases and should not be interpreted as giving specific advice or guidance.
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