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Settlements – An appeal for sanity. By Rebecca Benneyworth

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3rd Sep 2007
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Gavel The announcement after the end of the successful appeal by Geoff and Diana Jones was not entirely unexpected. There is no doubt that the Treasury would see a return to the “bad old days” of income splitting by husband and wife companies as unacceptable. In the period since the Arctic Systems case has become publicly known advisers have erred on the side of caution when advising clients about structure in businesses between married couples.

The outcome of the earlier appeals which found in favour of the tax authority sharpened that concern, and most practitioners had modified their advice to clients potentially affected accordingly. New clients were set up with a more conservative shareholding structure, and the main concern for many was the risk that if the tax authority won the case how many businesses would be faced with a “backdated” assessment of tax under the settlement legislation, and to what extent this would become a “postcode lottery” to use a common term.

That worry has of course receded with the success of the taxpayer in the House of Lords. But the announcement that the law will be changed has brought another concern. Of course a change in the legislation will not bring with it the concern about retrospective tax liabilities, and the consequent fall out for our clients, but it still raises worries about exactly how new legislation will work to prevent or discourage “abuse”, but not impact on commercial arrangements. The announcement made clear that consultation and discussions would be used to make sure that commercial arrangements were not affected.

However, my serious concern is that those dealing with this area seem to have missed the point entirely, even in the laudable aim of protecting “commercial” arrangements. In the case of most husband and wife businesses I meet the arrangements are far from commercial, are not intended to be and never would be, but this does not make them tax avoidance. Married couples very often do not apply commercial logic in their dealings with each other – some do of course, but in my experience it is more unusual than not. So is it these few “unusual” cases which would be exempt from scrutiny under the new law? And how will the desire to prevent abuse impact on the practical arrangements that married couples have in their entire lives (not just their business lives)?

We might consider a married couple who go through a number of changes in their business and personal relationship. Let’s say the business is started up by the husband when he is made redundant, and his wife helps out with administration in the evenings, as she has a full time job. Some years later she leaves work on maternity leave and decides not to return. Her years at home with the children allow her to give more support to her husband in his business. Some years later, he decides that a further course of study would help him develop the business further, and she takes over a lot of his role in the business, while he studies and does the after school childcare. Later again, an elderly parent needing care forces one or the other to take a back seat in the business – or maybe illness or another reason.

These are not commercial arrangements, but the function of a couple who live and work in partnership with each other, but let us return to when the business was set up. Imagine they each subscribed for one share in the company and drew the profits out largely as dividends throughout. How would any new “income splitting” rules be applied from year to year? Inevitably it seems to me that each partner’s role in the business would have to be valued to determine a “fair” return for their input, and this used to determine the tax outcome. In some years one would be the beneficiary of income splitting and in some the other. The complexity that this would lead to, and inevitably the arguments about whose contribution is more valuable from year to year are surely not a productive route to go down.

But how to discourage a return to the “bad old days” in a practical way? I’m afraid I do not have a solutions for this, as for every “abusive” case, I can probably find one on the other side of the coin.

A different question, I know, but perhaps it is time to go down the route of limited transfer of allowances and basic rate band for all married couples and civil partnerships? This is a highly political area, and one on which many will have strong views, not least the Treasury in view of the cost, but I find it very difficult indeed to find my way through a tax system which tries to treat a married couple (or civil partners) in the same way as an arm’s length commercial arrangement. They just aren’t the same!

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By AnonymousUser
04th Sep 2007 11:31

Joint returns
I think Rebecca's pointer to the way forward is spot on. The unfairness in the system is not that some couples can split their earned income (in the same way as all can split their unearned income, by a transfer of capital). The unfairness is that some couples can't.

My wife has a full time but unpaid job with a charity, so I earn the family income. Why should we be taxed so much more heavily than a two earner couple with the same household income? If there was a system which allowed the filing of a joint return by married couples / civil partners with joint allowances and rates, even if they were a bit lower than 2 x the individual ones, a large part of this problem would disappear.

Mike Truman

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By carnmores
13th Sep 2007 12:46

The Mormons would love this
as a matter of interest why do correspondents think that married couples and civil partners think such arrangements should be treated so favourably, is this discriminating against unmarried couples whose only entitlements are tax credits

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