This practice had not only been in common use, but at one stage was recommended by one of the Government's small business operations. Now individuals in business together will soon face a complicated assessment of whether income has been 'shifted' and how much income has been 'foregone'.
Andy Vessey from Qdos looks at the scenario.
Those of us old enough to remember the PG Tips adverts that used chimps to act out humorous scenarios, may recall the scene that involved a ady home owner offering cups of tea to a pair of removal men struggling to haul a piano up the stairs, by calling, “Coo-ee, coo-ee Mr Shifter”. Well HMRC last week served up something that will leave more of a bitter taste in the mouths of businesses, with the publication of their consultation document on the draft legislation on ‘Income Shifting’.
Following their defeat in the House of Lords in the Arctic Systems case this year we knew that proposed legislation was on the horizon to tackle that most heinous of practices involving spouses sharing their income and saving tax along the way!
That legislation has now been drafted entitled ‘Income-shifting’ and will be inserted in Part 13 of the Income Tax Act 2007 (tax avoidance) and it deals with how small businesses, run in a partnership or a limited company, are to be taxed as from April 6 2008. Whilst these businesses will normally involve spousal relationships, it will also affect civil partnerships and perhaps co-habiting partners, as the legislation refers to “individuals”.
For the legislation to apply, section 681B requires four conditions, all of which must be met:
(a) Individual 1 has party to, or has power over the relevant arrangements;
(b) Individual 1 forgoes income and the forgone income is individual 2’s for the relevant tax year;
(c) Individual 1 has the power to control the amount that is shifted; and
(d) The shifted income consists of distributions of a company or profits of a partnership.
The legislation will not apply in the following circumstances:
- To genuine commercial arrangements;
- Arrangements that are the same as those that would have been entered into in dealing with an unconnected party on an arm’s length basis;
- Gaining a tax advantage is not the main or one of the main purposes of the arrangements;
- The individual whose income is shifted has no power to control or influence the amount of income; or
- Notwithstanding that income shifting has taken place, there is no overall tax advantage.
The legislation has apparently been designed to reflect the realities of running a business and will catch those situations where the second individual is rewarded beyond their participation in a business. Sound familiar?
HMRC believe that only a minority of businesses will be affected but it is thought that some 30,000 small companies may be affected and as SME’s represent over 99 per cent of UK businesses, this legislation could suffocate entrepreneurship.
HMRC have also stated that administrative burdens on business will be minimal and that no additional record keeping will be required. Not for the first time, HMRC are in need of a reality check, given that in the event of any enquiry they may wish to see documentation showing how an individual has arrived at the amount of the income shifted and also records that demonstrates the nature and extent of the work done by individual 2, which may include contracts of employment, time sheets, board minutes, any research done on the market rates of pay for the duties undertaken by individual 2 etc.
Whilst the Government has opened up the legislation for consultation, it is believed that the legislation is fixed and therefore the consultation process will be somewhat restricted.
The legislation will be in addition to the settlements legislation (old Section 660A), so HMRC can potentially have two bites of the cherry in certain circumstances.
The Government seem to believe that husbands and wives go into business together to avoid paying taxes but the reality is somewhat different. Long before there were any tax advantages of spouses sharing income, married couples have been forming businesses together, e.g, Copeman (HMIT) v Coleman (1939) is just one example where a husband and wife held ordinary shares in a limited company.
Qdos are currently in the process of reviewing its TLC660 insurance to consider the effects of this legislation and will make further announcements in due course. We will be doing everything we can to give contractors future peace of mind.
Shout99 has followed the events relating to Section 660 and income shifting. You can also read more about the background and the issues at stake in Shout99's Section 660 resource centre.
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Susie Hughes © Shout99 2007