Tax anxiety for Mr & Mrs Inc.

Husband-and-wife businesses are in a legal limbo over what tax they pay on dividends, awaiting a Lords appeal

Thousands of husband-and-wife businesses face continuing anxiety about their tax liabilities - and the possible loss of thousands of pounds in unpaid tax - as a result of HM Revenue & Customs being given leave to appeal to the House of Lords over the Arctic Systems case.

Conflicting interpretations of Section 660A of the Income and Corporation Taxes Act of 1988 lie behind the court case, which was lost by the Revenue at the Court of Appeal late last year. At present, many family companies choose to split dividends equally or pay most of them to the lower earning spouse, reducing their overall tax liability.

But the Revenue argues that dividend payments should reflect the involvement of each partner in the business and where they do not the Revenue believes it may regard the dividends as if paid to the higher earner. It says all or most of the dividends from businesses jointly owned by husbands and wives may be treated by the Revenue as the income of the higher earner. In many cases the Revenue is applying the interpretation back over the last six trading years - and charging interest on the unpaid tax.

Groups representing small firms have strongly supported Arctic Systems and its owners, Geoff and Diana Jones. The Joneses lost their case with the then Inland Revenue's Special Commissioners and again on appeal to the High Court, but won at Court of Appeal. As many as a third of a million small firms could be affected by the final outcome, with perhaps £1bn of revenue for the Government being fought over.

Disputes originated in 2003, when the Revenue began issuing demands to husband-and-wife businesses, sometimes for tens of thousands of pounds. For a short time last year, when the Court of Appeal upheld the Joneses case and rejected the Revenue's argument, there seemed to be good news for the businesses affected and clarity over the legal position. There is no date for the House of Lords hearing, so the situation is likely to remain unclear for some time.

Revenue & Customs has issued advice to businesses that believe they may be affected by the case. The Court of Appeal decision represents the law as it now stands, but if any businesses seek on the basis of that decision to close outstanding Revenue enquiries into past accounts the closure application will be opposed by the Revenue until the situation is clarified.

The Arctic Systems' legal action has been actively supported by the Professional Contractors Group. PCG chairman Simon Juden said: "We are naturally disappointed that HMRC has chosen to prolong the uncertainty for thousands of family businesses, rather than accepting the unanimous verdict delivered by three of the most senior judges in the land. We strongly believe that where a husband and wife share the burdens and hard work of running their business, they are both entitled to share in the reward. This is consistent not only with Norman Lamont's clear intention when he introduced the independent taxation of spouses, but also with standard practice in the divorce courts."

Chas Roy-Chowdhury of the Association of Chartered Certified Accountants, questioned the Revenue's judgement in appealing, on the grounds that the case's ultimate judgement would still not create a clear precedent with each business situation varying significantly. "The result is that businesses will have to live with the uncertainty," he said.