Government examining business taxes

The Office of Tax Simplification (OTS) is looking at this and a number of other controversial taxes on firms, such as National Insurance and IR35.

John Whiting, tax director at the OTS said: "[Income splitting] is in the pretty-difficult-to-do box because it has been looked at a heck of a lot. We have to come up with some ways forward. I hope we can come up with some quick tweaks that can make a difference, but I am under no illusions that some of the things we could come up with will require some serious study."

The House of Lords rejected attempts by HM Revenue & Customs to stop income splitting in 2007 using a law from 1936 in a case involving a small IT firm called Arctic Systems. However, in September it successfully argued in court that a firm had evaded tax because the couple drawing the dividends from their business paid the monies into a joint account.

The practice of income splitting, such as a husband and wife owning the family business with only one of them generating the vast majority of the income but sharing the profits equally, is widespread in the owner-managed business sector. We remain in a position of considerable uncertainty following the high-profile Arctic Systems case and, in the main, people have left the ownership of jointly held businesses untouched whilst we wait for clarification through the long-awaited change in the law. It is hoped that the inevitable change in the law will not affect the owner-managed business sector detrimentally at a time when there are significant other pressures due to the economic downturn, but this cannot be guaranteed.

One possible radical solution would be to move onto a system of joint husband and wife taxation where allowances and tax thresholds are combined, which is similar to the US approach. If this were possible, the issue of income splitting is essentially removed as the unused tax allowances of one spouse can be used by the other as an automatic right. This could not be implemented without significant consultation so will not be the quick fix that the OTS would like to find.

For further information, contact:

Tim Stovold, partner at Kingston Smith LLP
Tel: 020 7566 3814
Email: tstovold@kingstonsmith.co.uk