The recent small business tax test case that was lost by Geoff and Diana Jones could cost family-run small businesses substantial sums in backdated tax.

The facts of the case: common corporate structure used by husband-and-wife businesses amounted to an "arrangement" under the so-called settlement provisions of the 1988 Taxes Act. Accordingly, income from dividends received by the non-earning or low-earning spouse had to be taxed at the same rate as the main earner's income.

Mr Justice Park, one of the High Court's most experienced tax judges, agreed with Inland Revenue's Special Commissioners previous decision that tax was properly claimed by the Revenue on dividends distributed to Diana Jones by Arctic Systems (a small IT business).

But the judge also gave extensive reasons for his decision. He said he believed fears that every small business tax case involving husband-and-wife companies would be affected by the "Artic Systems Case" were greatly exaggerated.

If a husband and wife team set up a joint company and ran it together, it did not follow from the Arctic judgement that the husband was necessarily going to be taxed on the wife's dividends.

Mr Justice Park pointed out that it was a feature of the Arctic situation that Mr Jones had provided funds for the "settlement" by working for the company in return for a salary that was below his true earning power.

It would be harder for the Revenue to establish that there was a "settlement" or "arrangement" in which the husband was the settlor, if he was being paid the true going rate for his work, the judge suggested.

The ruling was met with disappointment by the small business community.

"Small business owners will be extremely worried about the implications of this decision," said Andy Mowland, head of research at the Forum of Private Business.

"Business owners will now be looking over their shoulders to see if the Revenue are going to come and knock on their door"

"It must be remembered that a spouse often shares the risk but not the reward of the business," said Mr Mowlah.

"Is it really worth the Revenue pursuing such businesses for small sums of money and seeking to impose complex tax regime based on the uncertainties that surround settlements legislation?" he asked.

David
Small business Resource

Based on article in FT