Section 660 explained, from 1920s settlements law to a 42,000 tax bill

Section 660 – the background

The 'offending' piece of legislation is known as Section 660 and relates to Sections 660a to 660g of the Income and Corporation Taxes Act 1988.

It originally dates back to the 1920s when it was known as the 'settlements legislation' and it had something of a rather romantic origin. The purpose of the settlements provision is to give somebody a right to income but not to the underlying capital. This was not that unusual in the days when heirs to nobility married showgirls. His family would want to ensure that, while the new bride would be kept in a status now befitting her position – she couldn't get her hands on the 'family silver'.

The Inland Revenue's weapon against this has been anti-avoidance legislation – and it is this new interpretation which is causing so much concern for small family businesses nearly a century later.

The Inland Revenue

The Inland Revenue says this isn't new – which has a further disadvantage for small business in that it means that the Revenue can – and is – seeking back taxes up to six years.

Certainly the Revenue is taking a new approach which has surprised some of the country's leading practitioners and many thousands of accountants and advisers who have been recommending small businesses arrange their affairs in this manner for some time.

After growing concern among practitioners that the Revenue was changing its approach to this, the Revenue issued a Tax Bulletin in April 2003, which attempted to clarify its position with a series of examples. Some experts thought this was worse than had previously been anticipated.

In a nutshell, the Revenue takes as an example the case of a business owned by a husband and wife where the shares are divided. One of the parties is the major fee earner who receives a salary from the business. The profits are then paid out as dividends between the shareholders – the husband and wife. The Revenue claims this is a transfer of earnings from the higher tax payer to the lower tax payer in order to avoid tax – and is pressing that point with hefty backdated tax bills of up to £42,000.

Tip of the iceberg

Geoff Jones and his wife Diana set up their IT consultancy, Arctic Consultants, 13 years ago. They had regularly filed their tax returns on time with the assistance of experts and without any queries from the Revenue – until 18 months ago when a tax bill for £42,000 arrived through the letter-box. At first they thought it was a mistake, but a few phone calls later, they realised it was all too real.

Geoff Jones said: "The Inland Revenue is claiming that my wife was not entitled to dividends and that any money that she had received should have been taxed against my higher rate. Consequently this unexpected bill came ,backdated over six previous years. Obviously a major shock to us."

The Revenue seems to be saying that, although both Mr and Mrs Jones draw salaries from the business and contribute to it in different ways, Mr Jones is the business's fee-earner and therefore the business's profits should be his and that he is using the dividend route to give his wife income, which would otherwise be his. From that the Revenue concludes that he is avoiding tax because the income from the dividends has been taxed at his wife's basic rate of income tax rather than his higher rate.

In practice what this means for the Jones's is a Revenue demand back-dated for six years for £42,000. The assessment comprises £30,000 in unpaid taxes, plus £12,000 interest, which continues to rise as the Jones's dispute the assessment.

UKTECH, the UK's largest freelancer network, has set up a free information centre and an assessment decision-tree for businesses who might be affected by Section 660. Andy White from UKTECH predicts the Revenue could be looking to raise one to two billion pounds from small family businesses by using this measure.

Andy White said: "This is a retrospective stealth tax on family businesses and all the indications are that this case relating to Arctic Consultants is the tip of the iceberg. Up to a million small family businesses could be affected at this moment in time. Because the Revenue claims this isn't a new measure, it is now a real and present danger for small businesses throughout the country and they should take action to protect themselves and their businesses.

"Hundreds of thousands of small family businesses could be facing backdated demands for up to £42,000 for tax liabilities they had no idea they were incurring. It is shameful that small family businesses have to face this unfairness and uncertainty which could force many businesses to close down."

Advice

This is a new development for the small business community. Experts are still coming to terms with the nuances of the Revenue's announcement and accountants, lawyers, consultants and lobbyists will be gearing up to argue and debate the detail, the fairness and correctness of the Revenue's interpretation.

But, at this moment, it is the Revenue's interpretation of Section 660 which small, family-owned businesses have to deal with.

Andy White of UKTECH said: "Small businesses should not ignore this, but neither should they be panicked into closing down their businesses or restructuring them. You cannot change the past, but you can strengthen your position and protect yourself and your business.

"The first thing to do is to find out if you could be one of the businesses at risk and then ensure you have access to information which can help you make the right decisions for your family and your business."

UKTECH has a free information resource for businesses that think they might be affected. This resource includes an online decision tree to assess your status and, for those who might be affected, a free Section 660 briefing document.

Section 660 decision tree