Husband and wife teams do not have to come in from the cold

Husband and wife contractors need not necessarily panic and rush to change their tax arrangements as a result of the recent Arctic Systems case in the High Court, which went against directors Geoff and Diana Jones. However, they should certainly make sure they have legal expenses insurance in case HM Revenue and Customs come calling in the future.



That is the view of Barry Roback, Chief Executive of JSA, the UKís No.1 accountants for contractors, who made a significant contribution to the Professional Contractors Group (PCG) Appeal Fund so that this case could be tested in the High Court.

Roback points out that the circumstances of Arctic Systems was quite specific, and that the High Court judge had gone out of his way to say that he didnít think that the ruling would apply to all husband-and-wife companies. Roback thus emphasises that husband and wife teams, who are currently splitting dividends from their limited companies, need to review their arrangements in light of this case but not necessarily to make changes.

The tax arrangements of Geoff and Diana Jones were as follows:

Mr Jones was effectively the sole fee-earner in the company

The company had a turnover of 91,000

Mr Jones worked full-time but drew a salary of only 7,000

Mrs Jones did four hours a week administration and drew a salary of almost 4000

After expenses and corporation tax, the couple shared the remaining 60,000 equally in dividends.

Says Roback: Arcticís directors fell foul of the tax man primarily because Mrs Jones was not a director yet received a hefty dividend, while Mr Jones only paid himself a tiny salary. Clearly there are many questions remaining, but in the meantime, most husband and wife teams should not be unduly alarmed or take any action without first taking further individual advice.

He adds that this case does not set a legal precedent and can only be advisory, not binding. The HM Revenue and Customs will need to look at every case on its own merits and take into account individual circumstances. The Judge made particular reference to the fact that Geoff Jones did not pay himself the ímarket rateí for his skills as well as taking issue with the fact that his wife was not a Director of Arctic Systems, Roback points out. Of course many husband-and-wife teams are íequal playersí, and it would be quite hard for the Revenue to apply this ruling as a general principle.

Barry Roback stresses that, while Section 660 of the Income and Taxes Act 1988 has been on the statute books in some form or other since the 1930ís, this is the first time that the provisions have been used to target the use of ordinary share dividend distribution. Accountants and tax advisors have for years advised owners of family companies to structure their shares in a way that they could take advantage of both spouses lower rate tax allowances. Even the Governmentsí own Business Links website was advocating this as a tax mitigating structure for companies until recently.

However HMRC fought the case on the basis that the Arctic situation constituted an íarrangementí within the meaning of the legislation, and that Mr Jonesí dividend income should have been taxed as if it had been received by her husband.

Barry Roback believes that the HMRCís pursuit of people like Geoff and Diana Jones, appears to be part of an on-going attack on family owned businesses. He adds: The decision to go on the attack smacks of a desire to squeeze some extra cash out of the tax system, particularly in the light of the Revenueís relatively poor performance in making IR35 stick he claims. The Jones had structured their business like many other husband and wife teams, but it would seem it was the fact that Mrs Jones was not a director, that put the HMRC sniffer dogs on her trail.

However the reality is that Gordon Brown is in love with stealth taxes and The Institute for Fiscal Studies has estimated that such tax hikes have raised the Government an additional 2.1 per cent of national income since Labour came to power in 1997. This is equivalent to 26.4 billion. Therefore if the HMRC finally wins this case, it can look forward to a useful additional income stream.

The PCG has now decided to take the case to the Court of Appeal in order to clarify the situation and because the judgement undermines the self-assessment tax system by leaving a host of questions unanswered. However Roback warns that this is a high risk strategy, as Mr and Mrs Jones and their supporters face the risk of not only the costs of a second defeat but also having to pick up the HM Revenue and Customsí own costs in the process.