Taxing times for couples in business together

Several high-profile showbiz stars, and MPs, have been looking anxiously over their shoulders lately because the Inland Revenue has decided to take a more critical look at husband-and-wife companies.

This relates to an obscure area of the law called settlements legislation, which was updated four years ago. But, because cases have cropped up, the Chartered Institute of Taxation (CIoT) wants the Revenue to explain what is going on.

Viv Rees, the CIoT's spokes-woman, said: "Tens of thousands of small enterprises, usually run by husbands and wives, could find themselves with demands for additional tax. And, as is so often the case these days, the individual is being put in the position of having to prove he or she is not guilty, rather than the other way around."

The Revenue says it wants "to prevent an individual from gaining a tax advantage by making arrangements which divert his or her income to another person who is liable at a lower rate of tax or is not liable to income tax". This can cover gifts between spouses or even trusts for children. But the area of greatest concern is where a high-earning husband or wife sets up a limited company for their income, then installs the lower-earning spouse as a director or in a nominal capacity, such as a secretary. The means the spouse's salary or dividends, which would have been taxed at 40 per cent, are suddenly taxed at maybe 10 per cent, or not at all.

John Whiting, a partner in PricewaterhouseCoopers, said: "These rules are anti-avoidance legislation and are fair enough. But we seem to have a new Revenue interpretation of the rules with an element of retrospection. They have not got a cast-iron case. But it is a complex area and people need to tread with care."

The key seems to be to have a substantial business, preferably involving other employees as well as visible assets such as cars, vans or machinery. The main income is then more likely to be coming to the business, rather than merely through one spouse. A family-run shop, for example, should be all right, because its income derives from customers patronising the shop rather than because of the owner's celebrity.

But, in a Dickensian phrase, the rules stipulate that spouses are not allowed to come to an arrangement which is "bounteous", which means "generously or copiously given", ie, over the odds. Other warning signs in the Revenue's eyes spell doom for deals which are "not commercial, not at arm's length or are wholly or substantially a right to income".

The Revenue cites the case of a two-man partnership as second-hand car dealers with no premises, buying and sellings through auctions and ads. Their assets are office equipment worth less than £1,000 and they usually have only a couple of cars in stock.

The pair make profits of £80,000 a year split equally, but they make their wives part of the partnership and split the profits four ways. The wives do no work in the partnership and there are no employees.

The Revenue says: "This is a bounteous arrangement transferring income from one spouse to the other. The legislation will apply and the two men will continue to be taxable on half the profits each."

'We all have clear roles within the company'

Don Clark runs one of Britain's leading independent financial advisers, Torquil Clark, from a former church in Wolverhampton, West Midlands. It is also one of the country's biggest family businesses.

Within its annual turnover of £4m and 52-strong payroll, the company also employs his wife Julie, her father and Mr and Mrs Clark's son, Alistair, 20. "We all have clear roles within the company," Mr Clark said. "Julie organises seminars and other events, my father-in-law does the gardening and maintainance and Alistair is on the client-contact team."

Mr and Mrs Clark own all the company's shares between them, but they have created an employee share-option scheme.