Thousands of small businesses could be forced to pay millions of pounds in retrospective tax if the Inland Revenue wins a test case going ahead on Monday.
The case concerns Arctic Systems, a small IT consultancy owned by Geoff Jones and his wife Diana, which is facing a £42,000 tax bill for the past six years.
The case centres on a common situation in which a husband and wife are involved in a business as partners or shareholders but their role in its day-to-day running differs from the proportion of their ownership.
For example, a husband and wife might own the same number of ordinary shares in a family company with one of them acting as the main fee-earner and the other taking responsibility for a range of minor company duties. In this way income “earned” by one can be shared and then taxed on the other resulting in a saving on tax.
The Revenue is arguing that income, paid for example on dividends, received by a non-earning spouse or other connected person should be taxed as the main fee-earner’s income.
Roger Williams, tax partner at Wilkins Kennedy, said: “If the decision goes the Revenue’s way it could be used to attack thousands of other small businesses structured in a similar manner. The ruling will apply retrospectively so the Revenue could be looking to collect hundreds of millions.”
The challenge by Arctic Systems is being funded by the Professional Contractors Group, which says hundreds of thousands of companies are structured the same way.
”The potential repercussions of this legal contest combined with the chancellor’s crackdown on small business dividends in his last Budget can only mean higher taxes for the small to medium enterprise sector,” said Mr Williams.
”This is the case not only for future income but potentially also for past arrangements previously accepted by the Inland Revenue. Our concern is that innocent family companies could become victims if there is a general clampdown.”
Businesses that could be hit if the Revenue wins will be small family companies run by people who draw a low salary and pay themselves mainly through dividends and where that person and others are paying tax at lower rates.
The Revenue would not comment on a specific case but said the legislation being applied dated back to 1936.
