Husband and Wife companies

One change which Alistair Darling threatened to introduce but has postponed until April 2009 is an additional tax on husband and wife businesses. The tax authorities were incensed by the way in which Mr and Mrs Jones had set up their family company "Arctic Systems Limited". The problem was not that there was a family company but that the Revenue thought that Mr Jones had earned all the profits and therefore should be taxed on all of the dividends (or almost all of the dividends) coming out of the company whereas the shares were owned equally by Mr and Mrs Jones and therefore she had an equal share. The case went through the courts and the conclusion last year was that what Mr and Mrs Jones did was perfectly legitimate and that they should be taxed in accordance with their legal entitlement to dividends paid by the company.

As a result, draft legislation was produced at the end of 2007 to try and make sure that circumstances such as the Jones' would give rise to higher tax liabilities.

The problem with the draft legislation was that it was so simple that it would catch almost any family business and would open those businesses up to an investigation by the tax authorities which would involve arguments about how much each member of the family had contributed to the profits of the company and therefore their entitlement to their share of those profits. We could foresee an enormous amount of paperwork simply justifying the dividends and salaries paid to husbands and wives. And the legislation was sufficiently widely drawn that it would not just apply to companies but also to any other form of family business, such as a partnership.

Given the stated importance of family businesses to the UK economy it seems a little strange that tax and administrative burdens are being placed on them when they are working hard (and sometimes struggling) to make a profit. The situation for the wealthy however is very different.

Some people may remember when households were taxed as a unit on the husband - so that he would be taxable on any income his wife might receive. Ever since the rules were changed so that husbands and wives are taxed separately, there has been a simple tax planning opportunity for households to make sure that the spouse with the lower income receives any passive income (income from savings).

The tax authority recognises that this is perfectly legal and correct.

It therefore seems strange that the Chancellor is now proposing legislation which says that the very wealthy are entitled to arrange their investments to reduce the overall tax burden but the family business will be penalised for doing exactly the same thing.

Presumably the difference is there are not that many families with sufficient wealth to make a difference to the exchequer whereas there are lots of family businesses for the tax authorities to have a go at.