Income shifting: a consultation on draft legislation

Comments from ACCA to HM Revenue and Customs (HMRC), February 2008.

Income shifting


ACCA is pleased to comment on the above consultation. We have participated in three significant consultation meetings in this area as well as with the exchequer secretary, at each of which we have expressed our views and concerns. While we appreciate that the policy itself is not being consulted on, ACCA would like to express its serious concern at the proposal to legislate in this area. We also consider that such an approach, where the policy itself cannot be considered by consultees, is not conducive to effective, sustainable, transparent and robust policy formulation.

Not to enter in a discussion about the broader policy issues will mean that what is likely to appear in legislation will be less than sound. We, together with the other representative bodies, would welcome a further meeting with ministers to discuss the policy issues. We would urge that no legislation is enacted until we are able to discuss this policy in more detail.

We are also concerned that through the hasty enactment of law in this area we are seeing the effective ending of independent taxation. Spouses will need to discuss openly with one another what income and taxes each is attributed in order to ensure that they are not caught by the legislation.

Income shifting within modern businesses

The decision in the case of Jones v Garnett, (known as Arctic Systems), requires the government to readdress the issue of Income Shifting and we believe it would be helpful to work with professional bodies such as ACCA in setting out appropriate guidance for their members and for the good of the business community. We find the general premises made within the consultation document to be wrong. For instance, on page four at Box 1.1 , the example is simply incorrect. It completely ignores the fact that the company has a Corporation Tax liability, which, at the soon to be introduced rate of 22% of £60,000, is £13,200. This compares to the lower Income Tax suffered under the joint liability of £10,344.

If such a self evidently incorrect example was being presented to ministers to justify the policy change then they may easily draw the wrong conclusions.

Regrettably life is not as black and white as is envisaged in the consultation document. In our view the proposals are likely to provide a significant disincentive to enterprise for very little additional tax revenue. We question whether this is really what the government wants. We explain below our views surrounding why any increase in the tax revenue is likely to be low.

Questions for consultation

Businesses do not operate in the very simplistic cut and dried scenarios set out in the questions. We suggest that the issues are considered in a more holistic way.

At 1.11 the government is keen to take account of the “realities of running a business.” But then at 1.14 it seeks to apply an arms length principle. Where the company is owned by a husband and wife and they are using their private property, for example, to run their business the whole concept is likely to become unworkable. How would a business apportion arm's length costs in that situation? The notion of applying arm's length principles totally ignores the practicalities of family run businesses where significant amounts of time and effort are provided by various family members as and when they are able and there is no stringent record keeping process being operated. All sorts of complex valuation aspects are likely to arise and we are very concerned about the resultant bureaucracy this is likely to create for small businesses

The government now seems to be proposing a much higher burden of proof and record keeping requirements for family businesses. We have already said in the meetings we have held with the Treasury that the overall impact of the proposed legislation will, mainly, adversely affect small companies which are not professionally represented. The companies which are represented will generally aim to ensure that they go through the additional burden of justifying the income shares of each spouse or family member.

There will also be an ongoing cost to producing the documentation to justify the income share, but the represented businesses will feel they have no choice but to pay these costs in order to ensure that they are protected from HMRC investigation in the future. We consider that all but a few of the affected clients of members of professional bodies such as ACCA will put in place appropriate safeguards under the proposed legislation. But in addition to this many may be forced to consider taking out suitable insurance to cover the risk of an investigation into this area by HMRC.

Where HMRC wished to enquire into the “payment status” of the business then that business would use the insurance cover to engage a specialist in this area to defend their case. Hence the government would probably obtain very little additional revenue from this legislation but merely serve to antagonise the business community and increase its own costs.

In reality, the two types of businesses which are likely to suffer under this legislation are firstly the small business that does not use professional advice and probably has no idea that they might need to. If they were investigated they would no doubt struggle to field any worthwhile technical arguments and would have to settle the additional tax liability. This could be considerable once the law had been in place for several years. Alternatively they might have no choice but to cease trading.

The second category of business which would be at risk would be those who knew they were caught by the proposed legislation but decided to ignore its consequences. While one might have little sympathy for this category of business it is quite likely that only a small number would ever be investigated and hence again there would be very little revenue gain for the exchequer. In addition it would be difficult to differentiate between the businesses who fall into the “wilful negligence” category and the ones above who were unaware of the law and made innocent mistakes.

With respect to paragraph 1.15 if the government is set upon adopting legislation in this area we recommend that any additional tax charge should be levied on the individual receiving the additional income, viz individual 2 in the nomenclature of the page. There are many reasons for this, but the key ones are firstly, that it preserves some vestige of the principle of independent persons for taxation, which otherwise is being casually swept aside by the proposed legislation in this area; and secondly, that it does not unravel or upset settlements which may have occurred when spouses divorced. It would be all too easy for a vindictive former spouse to seek retribution by providing spurious information to HMRC in order that the other former spouse suffered an increased tax charge. This could go back a number of years and involve interest and penalties. It would also undermine the commitment expressed in Question 4 to reduce administrative burdens.

Taking Question 4 further, we have already discussed with you at our meetings a set of criteria to help reduce the impact, especially for the unrepresented category of persons if this legislation went ahead. We set these out below. Where any one of the criteria is met then the taxpayer should be considered to fall outside the regime and need look no further at the requirements of the regime. Below are the three main exemptions, and two 'carve out' scenarios where specific payments should not be aggregated.

The three exemptions are:

  • where business turnover is below the VAT registration threshold;
  • where total business profits are below the start of the higher rate band plus the personal allowance - broadly speaking around £40,000;
  • where the total net assets of the company are below £20,000 making it highly unlikely that there would be any significant amounts of income to shift.

A business would be completely exempt if it satisfied just a single “exemption” above.

Where a business did fall within the scope of the legislation there should be simplification so as not to amalgamate specific income categories. There are two which we consider relevant:

  • economic unit carve out
  • minimum hours carve out

The economic unit exemption is the more important of the two. What this exemption is targeted at is that each family unit should be treated separately. Hence a company dividend payment going to husbands and wives would be a unit to take in to consideration for this legislation. But where dividends were also going to a parent or other family member, who received dividends because they had originally set up the company, but currently took little active part in the business then that person (or persons) should be a separate economic unit and would need to be looked at as such under the legislation, rather than through the amalgamation of dividends between the two, or potentially more economic units.

The minimum hours exemption is one which recognises that the hours worked for “tax credit claim” purposes should be accepted for the purposes of this legislation without having to under take further verification work.

The draft legislation

The draft legislation contained at pages 11 and 12 of the document is not especially helpful. We have already commented on the lack of understanding of businesses that the proposals exhibit. One specific area we would mention, in addition to the comments elsewhere, is on page 12 section 681E(1b), which is too widely drawn.

Section 681E(4) is also wide ranging and would require a clearance mechanism on its own as it would also apply to intangible issues. We have suggested at meetings, and would like to re-emphasise now, that it should be deleted entirely.


We have very grave concerns at the government pushing ahead with legislation in this area. The proposals are not well thought through and contrary to what to one might expect, do not amount to joined up thinking on husband/wife taxation. We have also gone to great lengths at meetings and workshops to explain what might be the best way forward.

In summary we consider that the government should not enact legislation in this area. At the very least the legislation should be deferred until all the issues which have been identified are resolved. We, together with other professional bodies, would be happy to work with the government to issue appropriate guidance of best practice to our members including clarifying the scenarios of “income shift” which can and cannot be commercially justified.

If the government does decide to go ahead with a legislative framework then we believe the result will be that those taxpayers who are professionally represented will almost certainly seek to ensure that they document appropriately, take out insurance cover and if challenged use help from specialists to argue their case. It will only be the unrepresented families and businesses and the ill advised who will be at risk. The net result would be that there would be very little additional exchequer gain from this measure, yet it will create significant burdens on business, especially small businesses.

We thank you for the opportunity to comment and hope that the government chooses to work with us and others on guidance, rather than proceed to issue unworkable legislation. In any case we will be happy to work further in this and any other tax area.