DON FISHER & CO

Business Development Specialists and Chartered Accountants

 

Income shifting

Update in Pre-Budget Report November 2008:

In his 2008 Pre-Budget Report, the Chancellor announced that there would be no legislation on income shifting introduced in the 2009 Budget.

2008 Budget update:

In his Budget on 12 March 2008 the Chancellor announced that: "The Government firmly believes it is unfair that some individuals can arrange their
affairs to gain a tax advantage by shifting part of their income to another person who is subject to a lower rate of tax. The Government considered the responses received to the recent consultation and believes that a further period of consultation will ensure that the legislation in this area provides clarity and certainty for businesses and their advisers. The Government now intends to introduce legislation through Finance Bill 2009 and will not enact legislation effective from 6 April 2008."

Following its announcement after its defeat in the Arctic Systems case, the Government has published a consultation on draft legislation to prevent a tax advantage being gained through "income shifting."

The new legislation is intended to apply to two forms of income:

  • profits from a partnership; and
  • company distributions, most commonly dividends

    It is broadly designed to catch married couples or civil partnerships who seek to share business profits that have been generated substantially by the efforts of only one individual in the relationship.

    Three other conditions must apply:

  • the individual who is doing "the shifting" is a party to relevant arrangements, or has the power to control or influence relevant arrangements,
  • that individual forgoes income (directly or indirectly), as this is shifted to another individual.
  • the individual doing the shifting has the power to control or influence the amount of the shifted income.

    The individual who has shifted his or her income to another individual will then pay tax and NI (as applicable to partnership profits) on the income shifted.

    The legislation is not intended to apply to genuine commercial arrangements, or arrangements that are the same as those that would have been entered into in dealing with an unconnected party on an arm's length basis. "The power to control or influence..." ensures that income from most PLC shares will not be caught by the proposals.

    In addition, the legislation would not apply where:

  • gaining a tax advantage is not the main or one of the main purposes of the arrangements;
  • the individual whose income is shifted has no power to control or influence the amount of the income; or
  • notwithstanding that income shifting has taken place, there is no overall tax
    advantage.

    The consultation document Income shifting: a consultation on draft legislation seeks comments on the draft guidance as well as the legislation, to ensure that the legislation is clear to businesses and their advisers, and that administrative burdens are minimised.

    The consultation period closed on 28 February 2008.

    Comment
    In a nutshell, the draft provisions effectively remove the spouse exemption from the settlement provisions where the income and capital concerned comes from a partnership or company. However, this is not an addition to the settlement provisions, they remain intact (and as revised after Arctic Systems). We have here all new draft legislation. The underlying problem in trying to legislate to prevent "income splitting" is that not every case is clear cut, and that in the modern era spouses in business tend to make varying contributions to business over time.

    A problem touched on in the Arctic Systems appeal to the House of Lords by Malcolm Gammie QC was the question as to whether you could ever compare in truly commercial terms a business partnership made between a married couple (the term includes Civil Partnerships here) to one between two otherwise unconnected persons. Aside from the fact that if the couple get on they might have a major commercial advantage over rivals because they can "talk shop" at all hours, and work more flexibly. The other difference is that if you have your spouse in business with you, they will often work more hours which means that arms length comparisons are not always possible.

    Andrew Hubbard, Chartered Institute of Taxation (CIOT) Vice-President agrees, he says "The reality is that family businesses do not and cannot possibly operate on a fully arms length basis."

    The CIOT says that it has grave concerns about the implications of the draft legislation and takes the pragmatic view that fundamental reform to the structure of small business taxation is necessary if small businesses are to be able to plan their tax affairs with any degree of certainty.

    Andrew Hubbard adds: "The CIOT accepts that what it prefers to regard as income sharing within members of the family unit is an issue which would need to be considered as part of that reform, but regards it as wholly wrong for the government to deal with this one issue in isolation."

    Francesca Lagerberg, Chairman of the Technical Committee at the ICAEW Tax Faculty, said:
    "The proposed income shifting rules are very widely drafted. They will catch many owner-managed businesses involving husbands and wives and other family members. The difficulty will be working out whether they are caught by the definition or not. Many spouses do not have formal meetings to discuss their business arrangements, they just have their own way of working together."

    The ICAEW is urging businesses to review the HMRC consultation document and to respond to its questions before the legislation is finalised. "The more practical examples that HMRC receive, which show where this will cause real difficulty, the better the chance of change" says Ms Lagerberg. "If HMRC wants to make this work it will need to consider offering some form of clearance procedure to help taxpayers work out where they stand."

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