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News - 28 April 2005

Arctic Systems decision chills SMEs

The decision by the High Court to back the Inland Revenue over dividend payments to husband and wife owners of small businesses might mean a radical re-think about how couples remunerate themselves.

Many couples receive part or all of their remuneration by awarding themselves dividends as shareholders. Dividends are not subject to National Insurance. If they are equal shareholders the dividends will be the same amount even though one partner may do more work than the other. If one partner is a low or non earner, their tax free allowance can be offset against the dividend and what tax they do pay will be at the lower rate of personal income tax.

The Inland Revenue’s argument, accepted by the special commissioners in the High Court, is that this amounts to an ‘arrangement’ under the 1988 Taxes Act and consequently the dividend for the low or non earning partner should be taxed at the same rate as the higher earner.

In the case of Arctic systems it was suggested that the husband in the partnership had accepted a salary well below his true earning power and this effectively swung the case in the Revenue’s favour. Mr Jones paid himself £7,000 in salary and his wife took £4,000. The rest of their remuneration was made up by splitting a £60,000 dividend equally.

If a partnership using the dividend arrangement can show that they both put in equal time and effort into the business they should not fall foul of this ruling but it will be incumbent on them to prove it not the Revenue to prove the reverse. It may well be a good idea for owners to start clocking in and clocking out or at least keeping a record of hours devoted to the business.


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