Taxman stalks business consultants

British consultants working in a range of industries are the latest victims to emerge from the high-profile S660 defeat of Arctic Systems, according to the country’s top tax experts.

The Inland Revenue and Customs is reported to be investigating nearly 100 companies and partnerships alongside the Sussex-based IT business, which lost its appeal at the High Court following a ruling against the sharing of profits across husband and wife partners.

The newly spotlighted partnerships account for what tax experts predict will be the Revenue’s revived clampdown on the settlements legislation, in wake of Justice Park’s ruling which found that high asset businesses, such as those with stock, are much less likely to fall foul to the 1936 law.

This means that other low-asset backed service companies, such as freelance writers and business consultants, are vulnerable to Revenue scrutiny, while other enterprises, like high street retailers can continue reducing their tax bill in the same way as practiced by Arctic owners, Geoff and Diana Jones.

“Arctic Systems Ltd did not have any major assets or worth beyond the personal goodwill of Mr Jones,” said Nichola Ross, of Ross Martin Tax Consultancy.

“If it had some property on its balance sheet or substantial retained profits this might have tipped the argument, as the whole arrangement or settlement would have led to Mrs Jones owning a slice of a valuable company.”

Should a company consider itself as a low asset business, then advisors suggest husband and wife partners should be careful about how much they depress the salary, if they want to avoid arousing Revenue suspicion.

“The core point remains; the question is what the other party puts into the business as a contribution to earning the money,” said Roger Sinclair, consultant at Egos, the contract specialist.

“With a low asset base business, it is difficult to see how that contribution can be cash towards the assets.”

In the Arctic case, it is understood that Mr Jones generated £91,000 in fees but only paid himself a deflated salary of £7,000, with the remainder split across both partners as a dividend, in order to reduce the tax bill.

“If he had paid himself £60,000 and the rest was a dividend the Revenue would not have taken the case,” said Stephen Herring, partner at BDO Stoy Hayward, speaking to the Daily Telegraph.

He added that selecting how much to pay is “a matter of judgement” and recommended that husband and wife partnerships ensure their rate is “certainly above the minimum wage.”

His advice stems from the High Court ruling against Arctic, during which Justice Park stipulated that husband and wife companies could pay themselves “market rate” salaries to avoid being caught by the legislation.

Simon Dolan, managing partner at SJD Accountancy, agrees: “Paying a market rate would undoubtedly stave off a revenue enquiry,” he said.

“The Revenue Inspectors career progression depends directly on how much money they bring into the coffers, therefore when looking for cases to review they will pick on those with the most to gain.

“Someone paying a salary of £7000 on an income of £90,000 stands to pay an awful lot more tax, than someone on £90,000 paying a £60,000 salary and distributing the rest as a split dividend. The same amount of work is required in both cases on the part of the Inspector, so which do you think they would choose?”

Ann Redston, of the Chartered Institute of Taxation, said that paying the ‘going rate’ to the main earner is a positive way to lower the company’s profile with the Revenue.

“Stephen [Herring] is right to say if you want to get yourself off the Revenue’s radar screen paying a market rate salary would be sensible,” she said.

Ms Redston warned however that the debate over remuneration is not the only implication of Justice Park’s decision, which is available this week in full text, but failed to exactly specify.

Egos explained: “The implications are that if you want to reduce an overall tax burden by spreading income across other parties, then you have to take greater care in relation to the relative contributions made by the parties.”

Meanwhile, Mike Warburton, senior tax partner at Grant Thornton, said his initial estimate that 200,000 companies could face higher tax bills as a result of the ruling was now “too high,” but equally the Revenue’s figure of 30,000 was “too small.”

“Frankly,” said Mr Warburton, “nobody knows” how many small firms stand to be adversely affected by Judge Park’s decision to uphold last year’s Special Commissioner’s ruling against Arctic Systems.

Simon Dolan said the implications of what appears to be a targeted attack on consultants or ‘knowledge based workers’ is part of a much wider government policy.

“They [the government] have been trying to clampdown on what they perceive to be tax avoidance by these companies for some time now, starting with IR35, then IR591, and now S660.

“They think that the tax advantages that are to be gained by operating under a one man Ltd company shouldn't be enjoyed by people working in the knowledge based economy, as they don't believe them to be running a ‘proper’ business.”

Dolan added this was “convenient” for authorities because the general population “don't understand anything to do with tax other than the Basic Rate and possibly National Insurance, therefore any ‘stealth’ attack goes unnoticed by the vast majority.”

He also advised husband and wife partnerships that an alternative to market rate salary would be for the ‘non working’ spouse to start contributing income at a reasonable level to the company through selling their skills.


24th May 2005

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