Family run businesses set to lose their tax break

As a result around 200,000 family businesses could now be forced to pay up to £1 billion in added tax if the case leaves a precedent.

The case was brought forward after Geoff and Diana Jones, who jointly run Arctic Systems, were issued with £42,000 back tax bill by the Inland Revenue under section 660a of the tax code - otherwise known as the 'married couples' tax'.

The rules were created in 1936 to prevent husbands going into business with their partners and paying dividends to them in order to qualify for lower tax brackets.

The case was heard by the Special Commissioners of Income tax in June and was supported by Professional Contractors Group (PCG); an organisation dedicated to furthering the rights and interests of freelance businesses.

The decision was not unanimous with the view of the senior Commissioner prevailed by way of a casting vote.

PCG chairman Dr Simon Juden said: "This result adds to the uncertainty and confusion surrounding the taxation of family businesses.

"If two highly expert Commissioners of Tax cannot agree on a case such as this, it is hard to see how a small business is properly to assess its own tax bill.”

"We are naturally deeply disappointed at the outcome of this important case and concerned about the implications for other family businesses, consultancies and partnerships."

Recently the IR has focused on married couples who have equal shareholdings in a company and split dividend payments evenly; but where one of the pair does most of the day-to-day work.

Stepping up its campaign to catch tax dodging businesses, IR policy dictates that if dividends exceed the work done by the person, it will request the money to be returned.

The PCG argues that the IR has only recently adopted this interpretation of section 660a and has accused the organisation of taking advantage of a loophole in the tax system, much to the displeasure of struggling family businesses.

In contrast the IR argue that businesses are confusing two very different laws. A spokesman for the Inland Revenue said, “There is no parallel between family law and tax law, section 660 relates solely to the payment of tax in a specific set of circumstances.

“It does not affect ordinary business. It is only there to prevent people using contrived arrangements to avoid paying tax at the expense of those who pay their fair share.”