Replies to Queries - 2 - Plumbing, mitigating or avoiding?

A profitably self-employed plumber client wishes to benefit from the £10,000 nil rate corporation tax band by organising a portion of his business through a limited company to be formed specifically for the purpose. However, we are cautious of the content of section 775, Taxes Act 1988, but encouraged by Lord Tomlin's dictum in Duke of Westminster v Commissioners of Inland Revenue 19 TC 490.

If the purpose of the limited company were investigated by a dubious Inspector, can readers offer an opinion as to which argument might win?

(Query T16,117) - Dunston.

Section 775, Taxes Act 1998 was originally enacted to prevent entertainers from converting income receipts into capital as a means of avoiding punitive rates of income tax.

For the section to bite, there must be arrangements to exploit the earning capacity of an individual in any occupation that enables another person to enjoy all or part of the money derived from such activities and a capital amount is received by the individual and one of the main motives was the avoidance or reduction of liability to income tax.

Where the section applies, the capital amount is chargeable (under Schedule D, Case VI) in the year in which it becomes receivable, on the individual whose activities are being exploited.

If 'Dunston' wishes to look into the operation of section 775, I would refer him to Tolley's Anti-Avoidance Provisions written by Robert Maas and also to the Inland Revenue's Inspector's Manual at paragraphs IM4680 to IM4688.

However, looking at the case that is raised, my first thought is that the idea of incorporation is not to change income into capital, but to keep it as income, albeit with a much lower tax burden.

There is a requirement that another person must benefit from the activities of the individual; in this case this would be the company.

Having said this, there are two reasons why section 775, Taxes Act 1988 will not be a problem for 'Dunston's' client.

First, section 775(7) provides that where a capital amount is received in the form of shares, no charge under this section arises unless the shares are sold by the other person, in this example a spouse. So the receipt of dividends by a spouse would not cause a charge under section 775. Therefore the answer would be to let the company ceasetrading at a future date and for all value in the company to be extracted as dividends.

Secondly, the section only refers to professions or vocations and it does not apply to trades. Plumbing is a trade and so section 775 does not apply. The restriction of this section to professions and vocations is confirmed in the Inspector's Manual at paragraph IM4682. - Hodgy.

Section 775, Taxes Act 1988 is not a problem here, despite the use of the very wide word 'occupation' in section 775(1)(a). The meaning of this is confined by section 775(3)(a) to a profession or vocation. A plumbing business is clearly a trade. It does not have the attributes considered in the excess profits tax cases of Carr v Commissioners of Inland Revenue [1944] 2 All ER 163, Currie v Commissioners of Inland Revenue (1921) 12 TC 245, Commissioners of Inland Revenue v Maxse (1919) 12 TC 41 and Webster v Commissioners of Inland Revenue [1942] 2 All ER 517.

The main problem here is that this business is within the scope of the construction industry scheme - see sections 560(2)(a) and 567(2)(b) and (c), Taxes Act 1988. For the scheme to work at all, the receipt of invoices gross from significant customers (under section 561, Taxes Act 1988) must be of the essence.

Two problems seem likely to arise when an application for a certificate is made.

• The underlying arrangement being totally artificial, it is extremely difficult to envisage the proprietor being able to convince the Revenue that the minimum turnover requirement is likely to be met. (See section 565(2A)(a), Taxes Act 1988.)

• The necessary degree of business separation from the continuing sole trader situation is likely to be difficult to demonstrate, especially in the context of section 565(2), which imports section 562(2)(d). Segregating the operations is clearly essential in this context and this would be expensive.

Even if the nature of the customer base did not make this an insuperable problem, it would be necessary to demonstrate to the Inspector that there were, in fact, two separate businesses, if he were not to be likely to conclude that the company should be treated as a mere front for the proprietor's other business, i.e. a sham in law under the test in Snook v London and West Riding Investments Limited [1967] 2 QB 786. Indeed, unless the company had, at the very least, a separate telephone number, such a conclusion would be incontestable.

Moreover, if there are any employees, an application would need to be made for a pay-as-you-earn/National Insurance contributions 'paymaster' arrangement to be agreed to. In the absence of such an arrangement, the net earnings of those employees would gyrate from week to week in a manner likely to be totally unacceptable to them. The application in itself would put the Revenue on notice that something unusual was taking place.

Even if a two-business scenario could be established, the proprietor would be likely to find that expenses charged against the unincorporated business, and hitherto unchallenged, would be scrutinised for duality, with the possibility of rejection under section 74(1)(a), Taxes Act 1988 not insignificant. Although the civil standard of proof applies in litigation, in practice something nearer the criminal standard has tended to be required by the courts. See, e.g. Robinson v Scott Bader Company Limited [1981] STC 436.

This course of action could not, therefore, be recommended. - JdeS.

Issue: 3885 / Categories: