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famil affair
Page 35
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Many family haulage businesses may be under threat as the Inland Revenue targets such operations for tax avoidance.
Tre taxman is targeting smaller firms where the main earner draws a low salary but pays dividends to family or friends— especially spouses—who pay tax at lower rates. He is also challenging smaller partnership businesses where one partner does all the work but the profits are shared between husband and wife. This is the typical profile of many haulage businesses.
In total there are five factors that are most Likely to attract the Inland Revenue's (IR) attention:
• Main earner draws a low salary leaving more profits to be paid out as dividends to shareholders who are friends or family members; ✓ Disproportionately large returns on capital investments leg: 110,000 dividends on £50 of share capital); .,. Differing classes of shares enabling dividends to be paid only to shareholders paying lower rates of tax; .. Dividends being waived so that higher dividends can be paid to shareholders paying lower rates of tax; Il Income being transferred from the person making the most of the profits of a business to a friend or family member who pays tax at lower rates.
If your situation matches any of these you can now expect enquiries into your tax returns and demands for extra tax to compensate for the tax you thought you had saved. There are even stories of the demands for extra tax stretching back six years. In one highly publicised case the extra tax bill was over /40,000.
A common scenario will be one where the business is run by the main share Ei holder (Gordon). He owns 50% of the B
r shares in his company. His wife (Sarah) p holds the other 50%. The company makes Jg, profits of £50,000 after paying a salary of
s £10,000 to Gordon. The corporation tax on this profit is £9,500 leaving over .7' 240,000 to be paid as dividends. These "4 are paid equally to Gordon and Sarah as they each hold 50% of the shares. No further tax is payable. But, of course, if all of the profits had been paid to Gordon he would have had to pay some tax at 40%. The IR's latest guidance note identifies nine variations on this scenario. What they all have in common is that A has made a gift or transfer to B such that B benefits from dividends or profit shares that are generated by A. Regrettably, there is no easy solution.
Changed the rules
The IR says that they have not changed the rules. Technically this is true as the law they are relying upon, the settlements legislation, has been around for years. It was originally introduced in the 1930s and updated in the 1990s. But many taxpayers and accountants have difficulty accepting the new interpretation, as it is much stricter and more draconian than in the past. Certainly the IR's arguments are not all based on a generally accepted understanding of the law. But few people will be able to beat them without taking professional advice. And not even all professionals fully understand how best to defeat the IR's arguments. Some cases are bound to end up in the courts, which will be costly for everyone concerned.
The new interpretation applies equally to well established companies and to those that were only set up in the last year or so. Newer companies should find it easier to keep the taxman at bay. Each case depends upon its own facts, however, and it will inevitably be worth taking specific advice.
But in the meantime, there are some general pointers that should help you sleep easier at night.
Firstly, let's dismiss those situations that the IR says will not be challenged. These include companies where there are lots of employees and substantial assets. You also don't need to worry if the company pays all workers, including directors, a commercial salary. You should also be safe from attack ifthe dividends represent no more than a commercial return on each shareholding.
If you are still vulnerable, what can you do to reduce the prospect of the taxman seeing you as fair game?
Well, the tax year to 5 April 2003 is now well over although your tax return probably hasn't been filed yet. One thing you could still do if your salary was very low last year would be to vote yourself a bonus and to pay this within 9 months of your accounting year end. The aim would be for the accounts to show, in total, a fully commercial salary. But who's to say what a commercial salary would be for everything you do for your company? And paying extra salary means paying extra National Insurance Contributions so you shouldn't follow this idea without first checking whether the extra cost is really worthwhile. Each case will be different.
What about the current tax year ending 5 April 2004? Again, additional salary can help to deflect a possible challenge, but the additional National Insurance contributions may make this too high a price to pay. Other ideas will depend upon whether or not the second shareholder (if there are only two of you) was given their shares or paid the company for them. In the latter case your first line of defence would be that commercial salaries are paid and that dividends are proportional to the investment made.
Where the shares were a gift from a spouse the key is to be able to show that the shares do not have limited rights and that they are more than merely a right to income (dividends). In appropriate cases you may want to remove any restrictions on the shares and ensure that they will entitle the holder to a share of assets when the business ceases. This will all involve formal paperwork but it's likely to be worth the effort.
You would also want to arrange matters so that no dividend waivers are necessary in the future. Instead you could try redesignating all
of the shares as 'alphabet' style shares. That is where one shareholder has `A' shares, another has 'B' shares and another has 'C' shares, and so on. But, despite the legality of paying different dividends on each class of share, the IR may still mount a challenge.
Situations to avoid
There are a few other situations to avoid if you want to minimise the prospect of incurring the taxman's wrath: • Shares subscribed at par leg £50) that carry only restricted rights; • Shares given away that carry only restricted rights leg just to receive dividends); • Dividends paid to minor children.
Now let's assume that you have been unfortunate enough to be the subject of an IR enquiry. They've made some assumptions and have issued a huge demand for back tax. What can you do? Firstly, don't panic! I know that's easier said than done but good informed professional advice will invariably prove a costeffective investment—especially when compared with the size of the demand for tax, interest and penalties. If you ignore the demand the taxman will eventually come knocking to collect what he's demanded. Few taxpayers are able to achieve the best result without professional support.
A good accountant will know the right arguments to bring to bear against the taxman's assertions in each case. Because the new interpretations are pretty drastic there will often be plenty of scope for negotiation. Your accountant may well be able to persuade the IR to compromise and perhaps to withdraw its demands entirely.
This may be the first time you have read about this issue. But it won't be the last. And doing nothing about it could well be very costly.
• by Mark Lee Mark Lee is director of tax services at the independent tax consultancy WJB Chiltern plc and Chairman of the Tax Faculty of the Institute of Chartered Accountants in England and Wales.