Small Family Businesses facing Anti-Avoidance challenges from the UK Revenue!
(Arctic Systems Ltd).
In what is widely seen as one of the most important tax case judgements of modern times, with potentially far-reaching implications for a large number of small family businesses, the High Court has recently upheld the 2004 decision of the tax Special Commissioners which supported the Inland Revenue's controversial view of the application of the infamous "settlement provisions" in section 660A of the 1988 Taxes Act. For those small limited companies where husband and wife have equal shareholdings although one of them does most of the work this judgment represents a serious threat to their tax structure and could well mean that they have to reassess how they operate in the future.
This case, known generally as The Artic Systems case, involved a husband and wife team running a consultancy business and sharing their profits mainly via dividends. The Inland Revenue argues that the dividends should all be regarded as belonging to Mr. Jones. They contend that because he does most of the work and therefore earns most of the profits he should get most of the dividends. The Special Commissioners were split on the matter so the presiding Commissioner used her casting vote in favour of the Inland Revenue
The Judge in the High court has now upheld the revenue's view and dismissed the taxpayers appeal. He seemed to take a very simplistic view of the case and considered that Geoff Jones had entered into an "arrangement" with his wife whereby she could share in his earnings because she was shareholder and he worked for less than a reasonable salary thus enabling her to receive larger dividends as a shareholder than would otherwise have been available to her. He was therefore of the opinion that Geoff should be taxed on Diana's dividends as well as his own.
Bravely it has been announced that Mr. and Mrs. Jones are to appeal their case even further to the Court of Appeal so watch this space!
Since the release of the Arctic decision at the Special Commissioners the Revenue has published what it refers to as a detailed Guide to the Settlements Provisions on its website. This makes essential reading for any tax practitioner and includes a large number of examples of situations in which the Revenue says the legislation may or may not apply.
Readers should however proceed with caution. This “guide” represents the Revenue’s own very controversial opinions and some of the points it makes remain very provocative indeed. In particular it recommends that anyone seeking to examine a particular case should ask themselves what it regards as the fundamental question about such cases along the following ,lines: - would the businessman who it is argued is making the settlement pay someone other than a family member to do the work being done at the same level of dividends or remuneration?
Now whilst this seems a seductively persuasive test, in many cases it can be regarded as a self-fulfilling prophecy. It leads almost inevitably to the conclusion that in many cases the settlements legislation must apply because no arms-length member of the public would be paid such dividends or profit share. However in fact this may not be so. The Revenue in raising this question is arguably choosing, (perhaps deliberately?) to ignore an equally fundamental test: would the businessman who it is claimed is making the settlement be able to get any other ordinary person to work all the endless hours and to provide the extraordinary levels of support which many spouses give to their wives or husbands in their businesses for anything less than the level of reward seen in many small businesses accounts, either as dividends or salary?
The answer to this equally justifiable question is surely a resounding “no” in many cases. Most family business could not operate at all without the detailed and valuable involvement of both spouses. The eagerness with which the Revenue has released it guide with the heavy concentration on their chosen and it has to be said, far too simplistic, test indicates just how ignorant it seems to be of the methods of operation of most small family businesses and the contribution to them made by most spouses who hold shares in family companies. The Revenue test is based on a false premise – that effort and reward should be allocated pro-rata. It ignores the fundamental feature of most family businesses which is that most partners regard the profits as their joint property from the moment they are earned and as the product of their joint involvement in the business, notwithstanding who it might be that the customers regard just one of the spouses as providing the services which earn them! Furthermore most family businesses are in reality genuine partnerships in which the members frequently both regard themselves as playing equal if disproportionately busy roles.
This case is arguably the most important one to reach the courts for family businesses in perhaps 50 years. It is to be hoped that the Judges apply more logic and careful analysis in court than it appears the presiding commissioner did.
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