Officials 'find fault with income-shifting laws'

Treasury officials are said to have joined the chorus of voices from enterprise, tax and legal groups calling for higher taxes on 'husband and wife' businesses to be scrapped.

Since December, draft laws to strip away the "tax advantage" these firms gain by diverting income to the spouse on a lower tax rate have been widely attacked as unworkable.

Now the government's own employees have added their own condemnation to ministers, reportedly saying the new rules appear so difficult to follow that people will just "not bother."

Speaking to The Sunday Telegraph, an anonymous source close to the matter also said legislating against family firms would 'setback' the state's relationship with enterprise.

The PCG, the trade group for freelancers, has echoed the warning, saying many of the new requirements for jointly-owned businesses will put them on a collision course with the taxman.

"Tax inspectors will take an increasingly aggressive attitude towards small businesses as so many taxpayers will inevitably make mistakes when self-assessing under this legislation.

"Inspectors will come to presume, even more then they already do, that small businesses have got it wrong," the group said, "the relationship between HMRC and business will sink even lower."

Under the legislation, owners of jointly-owned companies will have to keep records of how much work they do, and at what rate, so they can prove the salary and dividends they receive are justified.

It also requires anyone who is aware that they are sharing their income – known as 'income shifting' – generated by their trade to another person to declare this and pay tax accordingly.

The legislation would not apply if there was a "genuine commercial arrangement" and HMRC believes tax reduction was "not the main or one of the main purposes" of the arrangement.

In other words, this latter requirement dictates small businesses would have to somehow prove that they had no intention of avoiding tax by choosing their structure.

The PCG reflected: "The proposals show a total lack of understanding of how family businesses operate: applying 'commercial' tests to them is a nonsense, because they only exist, and only operate, by virtue of family relationships, not 'commercial ones.'

"Applying the new rules, particularly with regard to applying 'market rate' values to work done within a family business, will be impossible to do with any certainty. Accordingly, businesses will be unable to meet their obligations under self-assessment."

The Federation of Small Businesses has pointed out that the legislation intends that people will self-assess and will be able to self-assess.

But Simon Sweetman, its tax chairman, warned it is "clear" that there is in most cases going to be no 'right answer', when the legislation takes effect next month.

"There may be a range of acceptable answers," he said, "This looks like fertile ground for disputes to me."

The Chartered Institute of Accountants think disputes won't only be between taxpayer and tax authority.

"Business owners caught by the legislation would need access to confidential tax information about their fellow business owners to be able to self assess properly yet without, it seems, the right to such information."

As a result, accountants fear it may be impossible for some businesses to calculate the impact of their 'income shifting', without breaking confidentiality and data sharing laws.

In its analysis of the new rules, the CIOT has told the Treasury: "The legislation would be unworkable and have no semblance of practicality or certainty.

"It will not be easy for taxpayers or advisers to comply with nor for HM Revenue and Customs (HMRC) to administer.

"The income shifting provisions are effectively imposing transfer pricing tests on the internal working of small or family businesses to a standard comparable to that required from the largest PLCs."

And although officials now apparently agree the rules are worrisome, in addition to whispers of a rethink on the most onerous requirements, the consensus among experts is that the government is determined not to concede, evidenced in part by its dogged pursuit of IT contractor company Arctic Systems Ltd.

Most experts estimate that the legislation – being attacked for imposing a family business tax on up to 30,000 small businesses – will net the Treasury around £200million a year.