Family businesses could now owe an extra £9,000 in tax after the High Court dismissed the appeal of a husband and wife caught in a government campaign against a previously accepted tax procedure.
Geoff and Diana Jones, who jointly run IT services firm Arctic Systems, were appealing a £42,000 bill in back taxes from the Inland Revenue issued under section 660A of the tax code, known as the 'married couples tax'.
The ruling reinforces the government's position to prevent family firms from trying to qualify for lower tax brackets by paying a depressed salary to the main earner and distributing profits in dividends equally between the spouses.
Experts warned the ruling will have major implications for up to 200,000 UK small businesses.
"Regardless of the rights or wrongs of the tax issue at stake…the main problem is that tens of thousands of businesses have been advised by their accountants to set up their operations in this way because the Revenue has always accepted it," said Glenn Collins, from the Association of Chartered Certified Accountants (ACCA).
"If the rug can be pulled from under their feet so easily, it makes things very difficult for small companies to work," he said.
The case was brought before the High Court by the Professional Contractors Group (PCG), a not-for-profit organisation that represents the UK's freelance community.
"We will carefully consider Mr. Justice Park's ruling before deciding on our next course of action," said Simon Juden, PCG chairman. "Meanwhile PCG will continue to campaign for clarity, consistency and common sense in regulation and legislation."
The Inland Revenue is targeting married couples who have equal shareholdings in a company and split the dividends evenly. It has said it is looking at up to 100 other family firms it wants to take to court, and it's crackdown campaign is now expected to gain momentum.
"Diana and I are extremely disappointed with the outcome of this second hearing, not just for us, but also for all the other family businesses that contribute so much to the economy and could be affected by this unfair legislation," said Geoff Jones.
"I sincerely hope that this particular piece of legislation will continue to be challenged, in the interests of fairness for family business."