Arctic Systems: where next for husband and wife businesses?

With the Law Lords finally ruling in favour of Geoff and Diana Jones in the long running Arctic Systems case, small family businesses might be breathing a sigh of relief. Although HM Revenue & Customs (HMRC) lost the battle, will the government end up winning the war by changing tax law?

The case

Geoff and Diana Jones own and run an IT consultancy called Arctic Systems. Geoff is the major fee earner while Diana provides general administrative support. Like thousands of other couples with similar enterprises, the structure of the business is such that both parties have shares in the company, with profits extracted by way of dividends.

HMRC used an old piece of legislation to argue that the dividends paid to one spouse were really earned by and belonged to the major fee earning spouse. Therefore, HMRC argued, the dividends received by Diana should have been treated for income tax purposes as those of Geoff, a higher rate taxpayer. This meant a retrospective tax bill of £42,000.

Following several appeals, the Lords’ ruling in favour of Geoff and Diana Jones on 25 July 2007 was final.

The consequences

The uncertainty over the case left thousands of similar businesses concerned that they too could face large and potentially crippling tax demands. Now, husband and wife businesses are highly unlikely to be hit with retrospective tax bills like the one originally issued to the Joneses.

However, following the ruling, Exchequer Secretary to the Treasury Angela Eagle announced the government’s intention to introduce legislation to close what it considers to be a tax ‘loophole’ and end this form of ‘income splitting’.

Angela Eagle said: “Some individuals use non-commercial arrangements to divert income to others. That minimises their tax liability, and results in an unfair outcome. It is the government’s view that individuals involved in these arrangements should pay tax on what is, in substance, their own income and that the legislation should clearly provide for this. The government will therefore bring forward proposals for changes to legislation to ensure this is the case.”

So it seems likely that following a period of due consultation, new legislation could make arrangements like the Arctic Systems structure a thing of the past.

We will keep you up to date with any changes to the law. If you have any questions regarding your own circumstances please contact us.