Income Shifting proposals and problems. By Nichola Ross Martin

Lobbying MPs over income shifting proposals proved very effective. 184 MPs signed the Early Day Motion on the topic below and the government announced that it was postponing the legislation in Budget 2008.

Article dated: 8 February 2008

Summary
The government has proposed new legislation designed to prevent what it terms as “Income Shifting”. Income shifting is a practice of splitting certain types of income of one person between two (or more) people in order to make use of the available tax allowances of those individuals.

Continued...

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Comments

EDM 714 - Push on to 200?

Paulsoper | | Permalink

Well done all - the number of MPs signing now stands at 157 - of which 19 are Labour.

My MP said she would sign on 18th February but I discovered this morning hasn't yet done so - so I've sent her a reminder.

Follow this link and check:

http://edmi.parliament.uk/EDMi/EDMDetails.aspx?EDMID=34871&SESSION=891

Business Structure

AnonymousUser | | Permalink

It seems the implementation of this legislation is inevitable. I am currently in the process of starting a consultancy company (engineering and not IT) and would like to structure taking into account this legislation.

If my wife is the SOLE shareholder and I elect purely to be an employee of her company is this a potential route to minimise the impact. In this instance I would take a decent salary (below the 40% limit) and my wive would take dividends up to the 40% limit. Any surplus would build up in the company which, on winding the company up, my wife would take as a capital gain.

Am I mistaken in thinking that if I have no ownership of the company then I cannot be deemed liable to personal tax on the profits of that company?

Any advice appreciated.

Of course it does not only apply to IT consultants!

Taxi | | Permalink

Sorry, I have been away and only just had a chance to revisit this thread.

The examples above are to illustrate the stupidity of the rules, and yes, I chose IT contractors because was that not the business which featured at the House of Lords last year? You are free to substitute IT with anything else you fancy, how about TV chef or maybe MP's secretary/researcher?

The rules will apply to any type of business, which leads me to wonder about how you try and self assess a "tax advantage" when your missus is a non-dom eh? That is going to create an extra layer of number crunching!

Anyhow, no offense meant.

Family business tax

IANTO | | Permalink

Paul,
Yes, and this is why the greater community has woken up to the danger whereas they were not interested when IR35 was introduced. It was seen as a tax on IT consultants. The family business tax is being introduced as a result of HMG's failure to catch one IT business i.e. Arctic. It is also my contention that "genuine businesses" will not be targetted for investigation. No one has challenged my assertion that by and large, only IT consultants were targetted with IR35, and again by and large, the majority of contractors working through "Managed Service Companies" are IT consultants.

However, looking at the "logical" arguments, and being cynical, I know that HMRC are not logical, how can HMRC evaluate the contribution to a business of a non working partner, who is a director of the business as well as a shareholder? and as such shares the commercial risks of the company and is jointly legally responsible for the conduct and debts of the company.

Again we have a conflict of law. Company law makes individuals liable, but tax law will say that the non working individual is not entitled to share the profits, but is still liable for the debts. Much ike the ideology of IR35. You will pay tax as an employee (and more), but you cannot have employment rights. HMG continues to use the word "fairness", where is the fairness in IR35 and the family business tax?

The only winners will be those Legal rascals again!

John....

Paulsoper | | Permalink

With respect you are missing the point a bit - the legislation requires self assessment adjustments to be made by those who are affected - it does not require HMRC to make any sort of attack at all. If a taxpayer is affected they will be required to make these adjustments - it may be that HMRC will examine IR35 type company owners to see if they are doing what they are required to do - but IR35 did not compel anyone to accept it if they had a belief that they were not affected - this does. And to ignore it just creates a ticking time bomb...

Family busines tax

IANTO | | Permalink

Paul and Gb,
I hear what you are saying. However, as I've already said, despite the fact that the legislation appears to attack "genuine businesses", the thrust of the legislation is against IT contractors and make no mistake it will be IT contractors who will initially be targetted. Remember Arctic was an IT consultancy, not a corner shop, architect or accountant. I see no one has commented on the statistics of the challenges under IR35. As far as I can see it has been used exclusively against IT contractors, as I believe the new legislation will be. You'd have thought that after the hassle HMRC have had from the IT community, they would back off. But it's all about revenge now and not revenue raising. Let's wait and see if my forecast is correct!

More "non-IT" examples:

Anonymous | | Permalink

Income shifting examples from the CIOT

The trouble is that the consultation document title happens to be "Income Shifting" and so if I start calling it something else people will start asking if there is another new tax. Although, you will see from these alternatives that the CIOT prefer the phrase "income splitting".

In passing, I think the term comes from the states:
http://www.fool.com/taxes/2001/taxes010824.htm

"Income shifting'

IANTO | | Permalink

I see Ms. Martin that you are falling into the Government's nomenclature trap. These proposals should be called the "family business tax". Please also give examples of their effects on businesses other than those associated with IT. These proposals are clearly targetted at IT businesses and until now previous proposals, e.g. IR35 have, it seems, been used exclusively against IT contractors. Now that the general business community could possibly be targetted, I see that the "accountancy establishment" has at last woken up to realities of the issues. These proposals are a spiteful Socialist tax against successfull middle income earners and should be opposed at all costs. But then, accountants are part of the "establishment" aren't they?

Family business tax

IANTO | | Permalink

Gb. - I don't think you or any of the "genuine businesses" need be worried about these regulations. They are a blatant attempt to hit the IT contractor environment, which is why I take issue with Nichola Martin who in effect is propagating the Government line by quoting examples related to the IT community.

This is also why I prepared an example for the Accounting community to digest, although as I say, they will not be targetted as they are part of the "establishment". There have been very few if any non IT contractors targetted with IR35, or at least very few "non IT" targets have been publically published.

It is fairly and squarely another outrageous attack on IT professionals, and the rest, who were not worried about IR35, are now a little worried about the cast of the net.

naomi2000's picture

Income splitting

naomi2000 | | Permalink

The HMR&C examples seem to inhabit a world from the 1950s. Are there really enough home husbands and housewives married to high earning consultants and entrepreneurs to make this complex new legislation worthwhile?

Minor point...

Paulsoper | | Permalink

This excellent round-up talks about private company dividends - in fact the legislation extends to company distributions, any company distributions so that where individual 1 can exercise an influence of the payment of a dividend so that individual 2 receives a dividend which would in other circumstances would be individual 1's they are caught. Has anyone told Philip Green that his £1.2bn dividend to his non-resident non domiciled spouse could be caught? What about Gordo's new mate Richard Branson, has anyone told him, Alan Sugar, Andrew Lloyd Webber - these are all influential businessmen who 'own' and dominate their companies. Perhaps if the seriously wealthy realised the threat to their wealth they might pull a few strings on behalf of us all?

"Family business tax"

IANTO | | Permalink

Thanks for the reply Nichola. I understand your point of view, but I urge you to refer to the proposed regulations as the "Family business tax". The PCG is referring to them in this way whenever the subject is raised. remember that HMRC proposed the "Intermediaries regulations" which we successfully renamed IR35. We need to do the same with these proposals, so that the wider family business community realises that it's an attack on them as well.

Family business tax

IANTO | | Permalink

"Perhaps if the seriously wealthy realised the threat to their wealth they might pull a few strings on behalf of us all? "

But you and I know very well that these are not the targets of the regulations and they will never be targetted for investigation by HMRC.

More Tax Credits paid out

frauke | | Permalink

The majority of the companies I look after, that have husband and wives who a both shareholders actually work on an equal basis for their companies - so they should not have a problem - but if one should reduce the amount of work they do in the future, will it then suddenly become Income shifting.?

3 years ago I suggested to a client - he should consider making his wife a joint shareholder (not 50/50, but joint), as she had given up working to raise a family. He declined, as he felt it would be easier to claim family credit instead. Leaving any additional cash in the business to carry him through periods when business was slow.

I suspect the shareholders that currently claim the maximum in dividends to be Basic rate tax payers will just forgo the extra income and claim tax credits instead.

Another practical problem

Paulsoper | | Permalink

Many years ago a friend of mine was brought in as a partner by his father in business which sold heavy packaging machinery on an agency basis for german manufacturers.

The initial profit share was 75:25 even my friend did all of the work and his father took 75% of the profits, but it was his father's business.

Under the new rules is the father individual 1 allowing his son to enter the business and take a 25% share of the profits, or is the son individual 1 by allowing his father to take a disproportionate share of the profits for little effort. Of course it was the father's business so my friend had little option but to go along with this.

And in later years when the PSR was altered to 1/3 - 2/3, then 50:50, then 75:25 in favour of my friend, how will income shifting apply then?

John - IR35?

Paulsoper | | Permalink

It is true that the guidance issued by the revenue on the settlor interested trust position before Arctic ever hit the courts indicated that they were only interested in service businesses BUT... the House of Lords drew no such distinction in considering that there was a settlement in the Arctic case and someone at revenue HQ has decided to run with that here.

If you look at the examples that accompany the consultation document many of them are talking about ordinary trading companies with assets etc which would never have been considered as a settlement before Arctic. Even the latest Arctic guidance givbes an example - 8 - of three people in partnership to run a cycle shop - normal business you'd agree. Two of the three are married to each other and all three inject £10,000 on inception into the business. The spouse never does any work in the business and some years later we are told, each participant, after salaries for the two that do work, takes £50,000 as a share of profit. Not a setltlement says the revenue.

But under the income shifting this is caught, and although there is no similar example revenue thinking is that after allowing say £2,000 as return on capital this is an income shift of £48,000. Is it commercial, an arms length transaction? Would the working partners have allowed a third person, not being a spouse to inject £10,000 for a 1/3 stake? The House of Lords would not think so - as that argument was attempted and failed in the Arctic case.

Normal businesses with capital, assets, premises, trade etc ARE caught by these new rules.

Do not disagree, but it IS wider ranging

Anonymous | | Permalink

John, we do understand where you are coming from and what has given rise to your exasperation.
As Accountants, we are used to analysing the legislation so that we can understand where and how it impacts, in order that we can be in a position to give best advice to ALL our clients.
I believe many Accountants also felt strongly about IR35 and I am sure would find much common ground with your thoughts on it.
With IR35 we had the same position, we had to analyse and understand the legislation in order to see which clients it impacted upon, and advise them accordingly. Here we have a simliar scenario, but even more widely drawn and thereby possible effect on a wider range of clients.
I hope that makes sense and comes across in the genuine spirit in which it is intended.
The frustration here for me as an Accountant, is that I cannot actually see (yet) how it will be possible for me to advise clients and assist them to self-assess. The clients simply want to self assess and then put it behind them. Not spend the next few years worrying about whether HMRC will challenge them and spring a big nasty tax bill upon them. I regret the "don't worry about it", will not actually solve it.

I just don't think it is workable. STOP

Anonymous | | Permalink

I remain confused about the (real life situation) where I have older generation shareholders/entreprenuers, but the younger generation are now doing most of the day to day running of the business (and may or may not be shareholders) and there is undistributed reserves from the earlier years.
Who "earned" the profits remaining to be distributed and have HMRC given any (thought)/indication of how they would view a dividend to distribute reserves to such semi-retired shareholders.
Meanwhile myself and my unmarried spouse/partner are asking ourselves whether we are being instructed (by default) that it is okay for us to proceed.
(Incidentally, what is the going rate for a non-executive Director, or should I be asking a retired politician)

Some problems

LJCWBW | | Permalink

As ever with this Government an ill- thought out ruling.

They've not thought about the situation I have with one of my clients at the moment. Joint directors, joint shareholders, take minimum as salary and remainder as divs as per usual.

Mrs works fulltime on the business as so did hubby up to a few months ago when his work dried up so he decided to do a couple of computer courses which will bring him up to date and give him a better opportunity to get work elsewhere. No other income - all income is from wife's work.

He's now not worked for 10 months altho he intends to ...and its gone over their year end - will they be caught?

I have another similar client whose hubby's work has dried up because he was involved in a car accident.. they dont know what they will do in the future as they have had other things to think of - will they have problems? Could HMRC look on a year by year basis?

Family business tax

IANTO | | Permalink

Here is one of my examples Nichola -

A qualified accountant working for a large multinational company has felt for some time that she should set up in private practise. She decides that incorporation is the most suitable vehicle for the way in which she envisages that she would work. She hands in her notice, explaining her reasons for doing so to her employer.

The accountant sets up the new company in the way advised by the DTI and again follows accepted practice. The company issues 2 shares and appoints two directors. The accountant is appointed managing director whilst her live in partner, who also becomes a director, is made company secretary.

The shares are allocated equally, thus ensuring that neither director has a controlling share. The accountant is made an employee of the company. The accountant naturally has already made a substantial investment in a home computer setup and utilises the computer and space at her home as the company's registered office.

The company's customers are invoiced and VAT is charged on the services as the turnover of the company is above the VAT threshold.

The accountant's live in partner undertakes no duties for the company, other than being a director with legal responsibility for the company's conduct and debts.

The two directors decide to pay the sole employee a salary commensurate with an employed accountant and pays the remainder of the company income, after deductions for expenses, in dividends, pro rata in relation to the director's share holdings.

These arrangements would be caught Nichola, wouldn't they?

Frauke

Anonymous | | Permalink

One could write several books on how people abuse tax credits. However, I would not ever suggest that you advise your clients to commit any offense.

If it is found that someone is forgoing income, all the credits will be clawed back. I know that the risk is possibly low, as there is no requirement to submit company accounts with a tax credits claim, however, watch your obligations under MLR, as well as the provisions of the 2007 Fraud Act.

To clarify a point or two here:

Anonymous | | Permalink

The examples above are both mine, not HMRC's. The first it to show a typical cut and dried case of the sort that HMRC are trying to target, when one person does not work, but shares income all the same.

The second one is based on real life - a real business, to illustrate the problems in the real world, when both spouses are involved in a business, I have applied HMRC's guidance to the case to see what will happen in practice.