Immediately following its defeat in the House of Lords in the Arctic Systems case, HM Revenue & Customs (HMRC) announced its intention to publish draft legislation to address the situation where income is diverted (shifted) from one individual to another (usually a spouse or civil partner) who is subject to a lower rate of tax.
That draft legislation has now been published, along with draft guidance and a consultation paper.
The draft legislation will apply from 6 April 2008 where company or partnership income is shifted from one individual to another, and:
- the individual “shifting” the income (individual 1) is party to or has the power to control or influence the arrangements;
- individual 1 forgoes income that is shifted to another individual (individual 2); and
- individual 1 has the power to control or influence the amount of income shifted.
Where the legislation applies, individual 1 will pay tax and possibly national insurance contributions on the income shifted.
The legislation is not intended to apply where:
- the arrangements are genuinely commercial or are as they would have been, had they been entered into with a third party on an arm’s length basis;
- gaining a tax advantage is not the, or one of the, main purposes of the arrangements;
- individual 1 has no power to control or influence the amount of the income; or
- there is no overall tax advantage.
Clearly targeted at family businesses, a key element of the UK economy, the draft legislation is subjective and uncertain, and the draft guidance which seeks to aid its implementation does not necessarily reflect the reality of running such a business. Many family businesses do not and cannot operate on a full arm’s length basis, and cannot be directly compared to other businesses.
The subjectivity of the proposed rules will make it more difficult for taxpayers to self assess accurately, when completing their tax returns. More disputes with, and enquiries from, HMRC, are inevitable. This uncertainty, together with an increased record-keeping burden, and the possibility of an increased tax bill, may all have a significant impact on family businesses.
It is essential that you seek appropriate professional advice to understand and plan for the impact of the proposed new rules on your business. It is similarly important to review any existing income-sharing arrangements, in place up to 5 April 2008, to ensure that they can be justified in light of skills utilised, responsibilities, and risk taken. The use, for example, of different classes of shares to direct differing levels of dividends to individuals, probably cannot be justified, and therefore will no longer be accepted by HMRC. Vantis will be submitting representations to the Treasury on these new rules: we would like to ensure your views are represented. Contact us to discuss your situation and the changes in more detail or if you have any comments you would like added to our representations please let us have them by 1 February 2008.
Budget 2008 update: Following a large and vocal response to the recent consultation paper, the Treasury has announced that the income shifting measures will not now be effective from 6 April 2008, but will instead be included in next year’s Finance Bill. The year’s delay in implementation will hopefully allow for further constructive consultation and ensure greater certainty for family businesses.
If you need further information, please contact Brian Williams using the online form below.