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Comment
Unguided Missives
MIKE TRUMAN comments on the latest response from the Inland Revenue on section 660a.
Before taking on the editorship of Taxation, I spent most of my working week lecturing to tax practitioners. One of the topics I lectured on was small business tax planning, and obviously I dealt with the advantage of incorporating one person businesses, possibly with husband and wife shareholdings.
Comment
Unguided Missives
MIKE TRUMAN comments on the latest response from the Inland Revenue on section 660a.
Before taking on the editorship of Taxation, I spent most of my working week lecturing to tax practitioners. One of the topics I lectured on was small business tax planning, and obviously I dealt with the advantage of incorporating one person businesses, possibly with husband and wife shareholdings.
When the Inland Revenue's views on section 660A became known through Tax Bulletin 64, I started asking attendees at public courses whether they had ever had an enquiry into a client's return based on this section. In an audience of a hundred people, it was rare for more than one hand to go up. Yet when I asked who had clients which, on the Revenue's interpretation, would be affected by the rules, almost every hand would go up.
The discrepancy between the Inland Revenue's view of the law and the rarity of enquiries worried practitioners. Over a year ago the professional bodies jointly wrote to the Inland Revenue asking for a response to several questions that arose out of the guidance given in Tax Bulletin 64 and an earlier letter sent to the professional bodies by the Inland Revenue. For a year there has been silence. The view was that the Jones v Garnett case, at that time expected early in the New Year, would have to be heard and decided before the Inland Revenue was likely to issue a further response.
The case has been reported before in Taxation and a further update is printed today ('The Setttlement Saga' by Anne Redston on page 202). On 18 November the Revenue issued consolidated guidance on the legislation as it sees it.
Unfortunately the guidance simply does not answer the questions raised by the professional bodies. It does little more than cobble together the various bits of guidance already issued, and shoehorns in a reference to Jones v Garnett without any awareness of the impact of the reasoning of BOTH Commissioners on the Revenue's argument. An appendix renumbers the examples without changing the references within them. Subscriber shares was Example 3 in Tax Bulletin 64, but is now Example 11. However, the example which follows and refers back to what is now Example 11 still calls it Example 3. There appear to be a few minor changes to the guidance in some areas, but overall it is a restatement of the pre-existing Revenue position.
The whole arrangement
The guidance persists in the original Tax Bulletin 64 argument that a simple motive test can be applied to the arrangements to see if they fall within the legislation:
'A good test of whether or not the legislation applies in a business situation is to consider whether the same payments would be made to a person who acquired shares in a company or a share of a partnership at arm's length. Or whether income is being paid simply because the recipient is a spouse or child or some other individual the business person might wish to benefit.'
Leaving aside the need for a verb in the second 'sentence', this approach cannot stand in the light of the Jones v Garnett decision. It depends on the Inland Revenue's analysis that you look at the whole arrangement, which is to transfer 'earning capacity' of one spouse into income in the hands of the other, and that the company is therefore just a part of the mechanism which achieves that. It was forced off that argument in the case because of the lack of a chargeable source, as Dr Brice explains:
'For the Appellant Mr Gammie argued that in this appeal the income which the Inland Revenue were seeking to charge on the Appellant was the income which they said that the Appellant should have drawn in salary and that was not a source of income chargeable to tax. For the Inland Revenue Mr Baldry argued that the dividends paid to Mrs Jones were income arising under the arrangement which was a settlement.'
Both Commissioners took the view that the income had to arise from property within the settlement, that the property was the shares, and the dividends was the income from them. Here is what Dr Brice said:
'The income arising under this arrangement was the dividends paid to Mrs Jones and that is the income arising under the settlement. The dividends derived from Mrs Jones' share which is a recognised source of income for the purposes of the Consolidating Act.'
Since the property of the settlement is the shares, and not the income as the Inland Revenue has previously argued, it follows that just because a transaction between spouses is not at arm's length it does not necessarily fall within the settlement legislation — it may be excluded by s 660A(6). The reasons why Dr Brice thought that subsection did not apply in this case have been aired in previous articles, but none of the implications appear in the Inland Revenue's guidance. Why, for example, does the guidance not say that if the spouse who is not a fee-earner has the majority of the shares, the exemption will apply?
Mark Lee, who chairs the ICAEW Tax Faculty, says the reason for the lack of clear guidance is Revenue caution: 'The Revenue fears that giving further guidance will lead to people planning up to the margin of what is permissible. However, the reason the professional bodies are asking for further guidance is so that those who are not likely to be affected by the provisions can rest easy that they do not have to make further disclosures'.
The numbers game
This brings the argument back to the numbers game. The Revenue's approach would not be so bad if the number of people affected was small. The professional bodies have already pointed out that, even on the basis of the 30,000 figure given by the Revenue, when it also says that only 100 enquiries a year are being raised, advisers will ask how people know whether they fall within that 100.
But the figure of 30,000 seems extremely low. In the years leading up to and including 2001-02, incorporations at Companies House were running at about 225,000 a year. For 2002-03 and 2003-04 they were 322,000 and 394,000 respectively. That's over a quarter of a million additional new companies, no doubt mostly as the predicted response to the £10,000 nil rate band. There is no clear source of information to say how many are husband and wife companies paying (or intending to pay) dividends, but it seems highly unlikely that the number for these two years alone does not exceed 30,000.
Trying to get to the bottom of this, I spoke to Tony Pringle, manager of the London office of Bureau van Dijk, (www.bvdep.com) which publishes the best known comprehensive database of UK companies, FAME. I asked him to run the same search as the Inland Revenue says that it ran — companies with two shareholders, one or two directors, which paid dividends in the past year.
His initial results were even lower than the Revenue's; around 23,000 companies. This seemed very low to me, and I queried it. 'Well, we only have about 180,000 companies paying dividends at all in the past year', he said.
Finally the light dawned. No commercial database, even one as comprehensive as FAME, can capture information that is not available from public records. They capture dividends as a 'below the line' item from profit and loss accounts. But most of the companies affected by s 660A do not file profit and loss accounts — they only file modified balance sheets as small companies. Dividend payment information is therefore not captured for these companies.
The basis on which the Inland Revenue claims to have identified only 30,000 companies as affected by s 660A therefore seems to be wholly unsound, as the profession has said all along. It is time for the Revenue to pay attention to what the profession is saying, give due credit to our knowledge of what is actually happening on the ground, and engage with us in finding an equitable solution.
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