Tax defeat for Arctic rallies small business

Small business advisors have breathed a sigh of disappointment after a High Court judge backed the Inland Revenue’s decision against IT firm Arctic Systems to overturn previously accepted tax planning.

The landmark S660A declaration that Geoff Jones had unfairly transferred some of his income in the form of dividends to his spouse, Diana Jones, so he could benefit from her lower tax status has implications for hundreds of thousands of husband and wife firms.

In particular, Arctic now faces the possibility of paying an extra £6,000, while other husband and wife partnerships face the prospect of additional tax bill of £9,000 on average.

But announcing his decision that “the Revenue claims for tax are correctly made”, Mr Justice Park said that the fear from small businesses that tens of thousands of other firms would be affected by the Arctic defeat was “greatly exaggerated.”

He pointed out that the Arctic case was unique because Mr Jones had provided funds for the “settlement” by working for the Sussex-based company in return for a depressed salary.

The judge added it would have been harder for the Revenue to identify that there was a “settlement” in which the husband was the settler, if he had paid himself the going rate for his work as an Arctic employee.

Strengthening his argument, Justice Parks said other husband and wife companies would not necessarily structure themselves so the husband would be taxed on his wife’s dividends.

But small business advisors have condemned the High Court decision, rejecting claims that the ruling poses no threat to the growth and survival of other business choosing to structure their payments in a similar way.

Glen Collins, head of Business Advisory Services at the Association of Chartered Certified Accountants, said: “Regardless of the rights and wrongs of the tax issues at stake - it is worrying that the court has effectively dismissed a wife’s contribution to the business in this way.

“The main problem is that tens of thousands of business have been advised to set up their operations in this way because the Inland Revenue has always accepted it,” he told the Times.

Roger Sinclair, legal consultant at contract specialist Egos, told CUK that the High Court decision represented a “disappointing result” for the small businesses sector.

“Whilst we will need to digest the full judgment before fully understanding the reasoning and figuring out whether any changes are needed to advice given to others in planning their positions, the message that comes across is that the potential obstacle of s660A remains in the way as yet another ‘gotcha’ for the entrepreneur. Does this government really want an entrepreneurial society? If so, it sure has a strange way of showing it.”

Meanwhile accountant Ann Redston, who advised the Joneses, said the ruling was more of a “bureaucratic nightmare” as it means smaller firms would now have to keep records of hours worked to allow the Revenue to check that going rate salaries were being paid.

“It's a black day for small businesses, especially for the freedom they have had to run their affairs as they see fit,” said Redston, speaking to the Daily Telegraph.

Simon Juden, director of the PCG, said he believes husband and wife businesses should be entitled to share the rewards of running a family firm, just as they share the risks.

“The fact remains that Geoff and Diana Jones acted at all times in good faith: they followed the advice given by the DTI; they followed the advice given by their accountants; and they wanted to pay the correct amount of tax,” explained John Kell, PCG researcher.

He told CUK: “The judgment made much of the fact that Geoff did not take a salary at the “market rate”; the implication of this is that family businesses must pay a salary at the market rate, a matter on which no guidance is available from the government. It therefore rests with the company to prove what the market rate is and that the wage paid reflects the market rate and the number of hours worked: the bureaucratic burden on small businesses has been ratcheted up.”

It is not yet clear whether the Revenue will use the judgment against Arctic Systems to pursue the nation’s 30,000 family-run companies for tax retrospectively.

If this were the case, the Joneses, who may appeal the High Court decision, would have owed the taxman up to £42,000.


29th April 2005

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