18/08/2007

Tax warning for Yorkshire husband & wife companies following ruling

Husband and wife businesses throughout Yorkshire are likely to find the taxman taking a very keen interest in their activities following a recent landmark judgement by the House of Lords.

The warning came today from Rebecca Malekottodjary, an employment law solicitor at Leeds and Bradford-based law firm Gordons, who highlighted the ruling involving Arctic Systems Limited, a computer consultancy run by a Mr and Mrs Jones.

Mr Jones generated most of the company’s income through his expertise while his wife did the book keeping and invoicing. She also looked after the firm’s administration. Both Mr & Mrs Jones paid themselves small salaries whilst the rest of the profits were taken out of the business as dividends which were paid equally in accordance with their shareholdings

Rebecca said: “The main advantage of these types of arrangements is that it can provide greater flexibility for all the parties concerned, with less likelihood that they will be classed as employees and for the individuals a reduction to their tax bill.”

“However, the Inland Revenue challenged the Jones’ arrangement as an anti-avoidance measure intended to reduce the tax properly due. They argued that Mr Jones should have been charged income tax at the higher rate of tax as he effectively earned most of the income of the company himself.”

By paying only basic rate income tax on the minimal salary Mr Jones paid himself and diverting the remaining income to be paid as dividends between himself and his wife they were able to drastically reduce their individual tax bills and save on employers national insurance.

Mr and Mrs Jones won the case and the decision has been hailed as a victory for all family owned businesses. However, the Inland Revenue has vowed to reverse this decision by the introduction of new legislation in the future to combat couples making tax savings by the payment of a large part of their income through share dividends.

Rebecca commented: “With this in mind, husbands and wives who provide services through a limited company – whether they own one or through a service managed company – would be wise to consider carefully whether or not such an arrangement may still be appropriate.

“This is already a complex area and, despite this decision, pitfalls remain. I would suggest that if individuals intend to continue providing their services on this basis that married couples keep clear records of the work done by each spouse. These should include their duties and contribution to the company and they should also document the company’s decision to pay income as dividends.”

For further information please contact Phil Paget at phil.paget@gordonsllp.com