The Revenue have lost what has been called the Arctic Systems case in the House of Lords.
This case dealt with a husband and wife who co-own a company. They paid themselves very modest salaries and then split the remaining net income of the company (which was high in relation to salaries and also in relation to sales since this was a consulting business) between them as dividends. The problems were twofold:
1) As the House of Lords found, the Jones arranged their company in this way with the intent of saving tax. They said part of the income Mrs Jones received was gifted to her by her husband. It just so happened that the Revenue lost the case because there was an exemption in the law that allowed this to happen.
2) As a result of tis gift, and the fact that dividends rather salaries were paid, less tax was received by the Revenue from this company than might otherwise have been the case.
Now, as a matter of fact I think the House of Lords made the right decision in this case based on current legislation. It had been stated in parliament that the settlement legislation which was the basis of the Revenue's claim would not be used for this purpose. As I believe in purposive legislation applied in accordance with the stated will of parliament it has to be right that litigation in contravention of the will of parliament should fail.
But, let's move on. The government has announced that now it has lost it will introduce legislation to ensure that "income splitting" as they call the practice undertaken by the Jones (and several hundred thousand other couples, I suspect) is outlawed. This is going to be immensely unpopular. It's also the right thing to do. They are quite right: this can be a straightforward abuse of the tax system. That happens when there really is a gift and low salaries exacerbate its value. I know it will make me unpopular, but since I believe in tax compliance, which means that the right amount of tax is paid at the right time in the right place, then this comment has to follow.
But, and I stress this very strongly, when the economic reality is that the partners do really contribute to the company, even if unequally, then they should be entitled to the return it generates, having allowed for reasonable (and no more) compensation for the time each has expended. If this is not the basis of new legislation then the law will not tax the economic substance of the transaction. That would be wrong. The economic substance of a transaction must match the taxation charge raised on it if tax is to be fair, which the Revenue say is their objective. This will challenge the Revenue, but anything less than this will harm small business in the UK. And that makes no sense.
Serious consultation, clear guidelines and ways of determining what is, and is not acceptable which are binding on all parties (assuming the truth is told) will be essential to make this work. The Revenue are trying to work in partnership with large business: they have to now show they can do the same with small business as well. Will they rise to the challenge? I hope so.
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Good heavens, Richard, this is about as bad a piece as I have seen in a long time.
You are of course entirely entitled to your political view as to how tax policy should be formulated, as to how tax strategy should be determined, and as to how you think the nuts and bolts should be applied.
And there is nothing remotely “wrong” about any of the underlying themes you present ; they are views fairly held, and to be fairly argued for.
But it is utter nonsense to present your views as pompously and arrogantly as if they are the only ones possible.
Perhaps I should elaborate on my comment. It derives from
>.
So do virtually all of us.
But it does not follow at all that your view of what is the right amount of tax at the right time in the right place is remotely sacrosanct.
Richard, surely the challenge they face here is to gracefully admit defeat. They do themselves no favours with a “we lost so we will change the law” statement
Richard, it is not an abuse of the system, the system allows for it!
If the system did not intend for this then it should have written tax legislation a bit better!
I read somewhere that in 1988 then Chancellor Lamont made the statement (about the introduction of independent taxation):
“Independent taxation is bound to mean that some couples will transfer assets between them with the result that their total tax bill will reduce. This is an inevitable and acceptable consequence of taxing husbands and wives separately'”
I totally disagree with you that a change in law to ‘outlaw’ what is being called income splitting is the correct thing to do, my god man, even Lamont knew it would happen and deemed it acceptable all that time ago!
For many of those c.200,000+ businesses that arrange their affairs in this way no doubt the spouse is the one that runs the house/children etc to allows the other to earn the money. The alternative is both spouses work they put the children into paid care and then what about the family unit, parents being able to be around for their children growing up etc?
Again Richard you are taking an unimaginative stance, towing the partly line if you will, you refer to the right amount of tax, but those who arrange their affairs in this way are paying the right amount of tax, the House of Lords has agreed that point! And as such their tax affairs are compliant, Richard, again your argument is one of towing a political line and supporting the view of HMRC, and as such you have become truly blinkered.
The facts are, Lamont, when independent taxation was introduced knew this would happen, more recently the House of Lords has upheld that this situation is correct, therefore the correct amount of tax has been paid and as such compliance with taxation legislation has been achieved, so why don’t you support it, after all it achieves all you purport to stand for?
As for the argument that these arrangements are unfair to the competition, lets not fools ourselves, the only other competition is usually similarly set up businesses, this is another example of a Labour government, and more importantly Brown, after having made a mess of the UK as Chancellor is now having to squeeze middle England ever harder, well PM we are fed up!
More importantly I feel, before these type of set ups are looked at one way or another, I would rather see the following dealt with: Non Dom rules, private equity deals, blatant and contrived ‘schemes’ that have no other purpose than to avoid tax, ministerial ‘expenses’ and the waste of tax payers money by a Labour government that is dealt with daily on a blog by The TaxPayersAllaince (http://www.taxpayersalliance.com/), these are by far the biggest abuses, then after all that Richard, if there is still a huge hole in the budget fine lets look at this, but lets be honest the above won’t be looked at, only the SME because they are the easy target, they are not rich enough nor powerful enough, it’s a disgrace!
Welcome to the UK 2007
Richard,
The way to make the problem go away, is the same method that made the income/capital conversion schemes go away.
Stop taxing income at different rates and stop taxing different business structures at different rates.
There is absolutely no evidence IMHO that such a differential is justified.
If it is right – according to recent legal decisions – for a wife divorcing her husband to have a share of the capital/income earned by her husband over the course of the marriage in recognition of her role as a support at home and in recognition of her moral/emotional support, why is it wrong for her to have a share during the marriage?
The idea that Mrs Jones did not contribute to the business would not stand up in a divorce court, so why should it stand up in a tax court?
What we really need is a proper settlement of what marriage is, what its rights and obligations are, and I don’t think HMRC is the body to bring it about.
Martin
I’m entirely baffled. Your comment is enmtirely without logic. What you seem to be saying is I can say what I like as long as you agree with it.
That’s absurd, if I might have your permission to say so.
Richard
Neil
You’re right – but this utopia is unlikely. I will, however, publish more on this next week
Richard
Alistair
You’re quite wrong. as I will show in a paper to be published early netx week, theer is an abuse happening here. Every accountant knows it. So it must be closed.
Along with other abuses, like the domicile rule.
Richard
Richard,
Either I have expressed my comment badly or you completely misunderstand (or both).
Your comment which gives the grief is the one (it did not come out in my posting for some technical reason) which says “I believe in tax compliance” – well, apart from fraudsters, who does not? – “which means the right amount of tax is paid at the right time in the right place”. Glory be, what is this supposed to actually mean in practice. I (perhaps wrongly) characterised it as “pompous and arrogant” – perhaps “motherhood and apple pie” would be a more moderate and accurate characterisation.
Your (personal) view then goes on to say that if both partners (married? – see below) contribute, even if unequally, then income splitting is not abusive (if I understand correctly – albeit perhaps I have misinterpreted). But what is an “economic” contribution in your eyes? Say one partner spends 18 years “raising the kids and looking after the home” – is that an economic contribution in your eyes? (the implication seems to be no, but again perhaps I misinterpret).
And where do we take this ; is the “Traditional” nuclear family of man, woman, children of relevance ; or not; or indeed other “stable” relationships, whethe opposite sex or same sex, or with children/without children?
You do not have to agree with me on any of the points to be “allowed” to say it, but you should not (IMO) present your view as the only one sustainable. And certainly not under the apple pie heading of “the right amount of tax at the right time in the right place” as if that were some objectively attainable fact. It is just sloganing.
To your
“I believe in tax compliance”
I commented
“well, who does not apart from fraudsters”
and should have added
“and apart from certain treasury ministers who remain unapologetic for defying parliament/democracy/the law in refusing to pay taxes because they do noty like them”.
Richard,
Utopia is something to strive for. Since equalisation of taxation of income is both (a) fair and (b) by far the most sensible approach for all then we should lobby hard for it. The current cohort in the Treasury might struggle with the idea that simple is both fairest and best but we must try and impress that upon them.
The other problem is that if you close the ‘income splitting’ loophole you introduce a couple of anomalies into the system (IMHO).
Firstly there is no real relief for the opposite problem of ‘income aggregation’ where an individual (usually a women) sacrifices their own earning potential (usually to organise child rearing) so that another individual can earn a bigger wage. That is punitively taxed at over 45%. I see no reason why that shouldn’t be seen (and rewarded) by society as the ‘partnership’ that it is.
Secondly there is the problem of physical assets vs. intellectual assets. You can split income (and capital gains) generated from physical assets quite legitimately and nobody seems to get upset. Yet if you do it from intellectual assets it is seen as ‘wrong’. Why is that? Why is can money generated from a Buy-to-let business be split 50/50 regardless of effort, but not from a consultancy business. I see no logic for that.
What’s your view Richard?
[…] Arctic Systems – and how to move on […]
[…] I wrote on this case, and as a result was challenged to rpoduce a suitable response. That I have now done. The full paper is available here. The summary says: […]
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