Expert View: Memo to the taxman: this goose will be spitting feathers

Do you ever wonder if the Treasury frets about increasing taxes? They worry about not collecting enough, but do they ever think it might be too much? Or stand back for a moment and say this can't be right.

A good tax system allows the maximum number of feathers to be plucked from the goose with the minimum amount of hissing. By that measure, the latest Treasury proposal on taxing families will have Mother Goose in a hissy fit. So hissy, she might say she's had enough.

The pluckers at HM Revenue & Customs (HMRC) have been fighting a court battle for the past five years to tax Mr Gander on dividends that his wife, Ms Goose, received from a company they jointly owned. (The names have been changed to protect the innocent.) Mr Gander worked for the firm and generated most of the profits, so the fruits of his labour found their way to Ms Goose's pocket indirectly through her dividends. HMRC did not like this form of income shifting, which allowed Ms Goose to benefit from lower taxes than Mr Gander would have paid had he kept all his earnings to himself.

The good news for taxpayers was that the House of Lords did not agree Mr Gander should be taxed on his wife's income. Ancient and uncertain laws on taxing benefits did not do what the taxman thought they ought to. The upshot is that HMRC has now issued a consultative document proposing to change the law from next April to stop families arranging their businesses to suit themselves. Or to put it in HMRC's terms, if an individual shifts his or her income to someone else through a partnership or company, then any tax advantage will be cancelled.

Is this an intrusion too far? Taxpayers have always accepted that they can't save tax by giving income away to their minor children, but the proposed new regime goes well beyond that.

HMRC now wants to look into family-run enterprises and demand that each person justifies for tax purposes his or her contribution to the overall earnings. So if Mr Gander doesn't work as hard as Ms Goose but they take equal pay from their business, Ms Goose will have to report this to HMRC and pay extra tax.

This means families will no longer be able to arrange how they own and run their firms without state interference. Why shouldn't Ms Goose be able to put money into a company that her children run, for example, without the threat of HMRC arguing that she should receive an appropriate return for her capital? She probably does it because she loves her children, not as a commercial venture.

What's really objectionable from a social perspective is that families will have to justify their contribution to the family business and stand behind their analysis for the benefit of HMRC. Who gets what return when Dad borrows against Mum's house and puts the money into the family firm? Who decides whether Auntie in the typing pool should be paid more or less than Uncle who drives the van?

Most families regard their assets as a shared pot and each does his or her bit to help it grow. If the pot happens to be a business, the same principles apply. But now HMRC wants us to keep timesheets (yes, that's what it's suggesting) to show what effort each family member is putting in to justify their relative pay.

And, of course, the legislation will cover all businesses, family- run or not. So every company and partnership will have to make sure its arrangements are strictly commercial and that there is no whiff of income shifting to save tax. It's strange that the draft legislation won't catch MPs who pass income on to wives employed as assistants. Perhaps that's being left for later.

Surely it's wrong, even in the interests of a "progressive" system (ie, raising more tax) to make families determine who earns what proportion of the profits of their business by reference to some commercial yardstick. And to compel them to waste time and money keeping records of these arrangements.

So down on the family farm, what lies in store for 2008? Ms Goose should not be surprised if the taxman calls to ask: "How many eggs have you laid during the past year?"

Alasdair Douglas is senior partner and head of corporate tax at City law firm Travers Smith. alasdair.douglas@traverssmith.com