| The Arctic Systems case has been much talked about over recent
years. The case involved a husband and wife who owned a company
50/50 and, broadly, took the profits out by way of dividends,
again 50/50. HM Revenue and Customs (HMRC) attempted to tax
the dividends solely on the husband, as he was performing most
of the work which generated the profits of Arctic Systems.
Following HMRC’s defeat in this case, the government
has published a consultative document which includes draft
legislation to prevent a tax advantage being gained through
what has become known as ‘income shifting’. This
legislation will potentially apply from 6 April 2008 to:
- private company dividends; and
- profits
from a partnership.
It will not affect dividends from
a quoted company or investment income from savings accounts
or from rental property (as long as the rental income does
not arise from a partnership business).
It is broadly designed to address the Arctic Systems sort
of situation, where one spouse or civil partner generates
most of the business profits but the other gets a proportion
of the profit and, overall, the couple save tax into the
bargain. However, the proposed rules are very widely drafted
and may catch many owner-managed businesses involving husbands,
wives and other family members, as well as businesses run
by people who are living together but are not married.
The proposed legislation refers to an individual who shifts
company dividends and partnership profits to another individual.
Three conditions have to apply:
- an individual who is shifting income is party to
an arrangement or understanding, or can control or influence
such an arrangement or understanding;
- that individual forgoes income (directly or indirectly),
as it has been shifted to another individual; and
- the individual who is shifting the income has
the power to control or influence the amount of the income
shifted.
If these conditions are met, the individual who has shifted
the income will be liable for the tax and any national insurance
due on the income shifted.
This is an HMRC example of a situation in which the legislation
would apply. Individual 1 and Individual 2 form a company,
each owning fifty £1 ordinary shares. The business
of the company is to provide the personal services of Individual
1. Individual 2 spends around five hours a week on back office
duties for the business. In the first year they each receive
a salary of £5,000 and dividends of £30,000.
The salary received by Individual 2 is considered to be the
market rate given the nature of the work done and time spent
doing it. The company has no significant assets or liabilities.
If Individual 2 has no capital in the business and bears
no risk the whole of the £30,000 would be treated as
shifted income because Individual 2 is already receiving
a market rate for the work done, has no capital in the business
and bears no risk.
Of course, if Individual 2 does contribute more to the business
than in the above example, then some or all of the income
will not be treated as shifted income.
The legislation will not apply to:
- genuine commercial arrangements;
- arrangements that are the same as those that would
have been entered into in dealing with an unconnected party
on an arm’s length basis; and
- situations where, even though income has been
shifted, there is no tax advantage gained.
Please note that this is not yet legislation and is subject
to a consultation process. We will, of course, be reviewing
our clients tax position before April and will keep them
informed of any further developments. However, if you have
any questions or concerns in the meantime, please do not
hesitate to contact
us.
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