Will you be ‘income shifting’?

You will no doubt remember the Arctic Systems case which has been much talked about. The case involved a husband and wife who owned a company 50/50 and, broadly, took the profits out by way of dividends. HMRC had attempted to tax the dividends solely on the husband, as he was performing most of the work which generated the profits of Arctic Systems.

Following HMRC’s defeat in this case last year, the government announced in the Pre-Budget Report that they would legislate against similar situations which they regard as ‘income shifting’. Draft legislation has now been published to prevent what the government believe is a tax advantage being gained through income shifting.

This legislation will apply from 6 April 2008 to:

company distributions, usually dividends, and
profits from a partnership.

It is broadly designed to address similar situations to that found in the Arctic Systems case, where one spouse or civil partner generates most of the business profits but the other receives a proportion of the profit and the couple save tax into the bargain!

Rules catch more situations

The proposed legislation is rather wider than was anticipated as it refers to an individual who shifts income to another individual. In order for a situation to be caught by the legislation three other conditions have to apply:

the individual who is shifting income is party to an arrangement or understanding, or can control or influence such an arrangement or understanding
that individual forgoes income (directly or indirectly), as it has been shifted to the other individual, and
the individual who is shifting the income has the power to control or influence the amount of the income shifted.

If these conditions are met, the individual who has shifted the income will pay the tax and any national insurance due on the income shifted.

The legislation will not apply to genuine commercial arrangements or situations where, even though income has been shifted, there is no tax advantage gained.

The proposed rules are very widely drafted and may catch many owner-managed businesses involving husbands, wives and other family members, as well as businesses run by non-family members, leaving many with a substantially higher tax bill.

We will keep you informed of any further developments. However, if you have any questions or concerns in the meantime, please do not hesitate to contact us.