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Leighton Reed Welsh family businesses beat the taxman - but for how long?

Thousands of married couples running businesses in Wales who have been facing the prospect of handing over £9,000 a year more to the taxman after a High Court ruling have been given a reprieve – but may not be able to breathe easy just yet.

Married businesspeople had been expecting they would have to pay the additional tax on dividends that they paid themselves following a long-running court case which has been eagerly followed by small
businesses and tax advisers alike in Wales.

It began when Geoff and Diana Jones, who own an information technology business, Arctic Systems, were told by Her Majesty’s Revenue and Customs (“HMRC”) that they owed an extra £42,000 tax on dividends they had paid themselves during the previous six years.

In essence, HMRC were arguing that Mr Jones was the main contributor to the business and as such he should have received and be taxed upon his fair share of the profit at a higher tax rate. Mrs Jones paid tax at a lower rate. HMRC argued that by taking a low salary and paying out most of the profit as dividends to himself and Mrs Jones, he was diverting his entitlement to profit to Mrs Jones and so avoiding tax.

The Jones’ appealed to the tax commissioners and later in the High Court, saying that husbands and wives, as directors of their own company, had always paid themselves nominal salaries from their business, but awarded themselves dividends - an accepted, commercial and tax-efficient way to proceed.

The High Court ruled in favour of the HMRC, but that was overturned by the Court of Appeal and upheld by the House of Lords.

In the worst case scenario, it had been estimated that thousands of husband-and-wife companies would have been affected if HMRC had got its way, with each married couple facing an additional tax bill on average of £9,000.

However, although the immediate threat has been averted, tax advisors like Broomfield & Alexander believe it will only be a matter of time before what the HMRC could not achieve through the courts, it will achieve through legislation.“The HMRC has retreated to lick its wounds for the time being,” said Broomfield & Alexander tax director Leighton Reed.
“But it’s extremely unlikely that husband and wife small business teams in Wales have seen the back of this. From their performance in courts, HMRC are clearly adamant that taxation of dividends paid in these circumstances has to be clamped down on. I fully expect we’ll see this rear its head through new laws in the years to come.”

Leighton added “It should also be remembered that Mr and Mrs Jones won their case based upon particular circumstances. The case should not be relied upon in other situations where HMRC intend to try and collect unpaid taxes for example, where dividends are waived so that higher dividends can be paid to shareholders paying lower rates of tax or where a company has differing classes of shares e.g. A, B, C and D shares enabling dividends to be paid only to shareholders with lower rates of tax. I would recommend that all businesses review their position. ”

Date: 29th August 2007