The discussion about the Office of Tax Simplification is gaining momentum as the body itself starts to get fully organised. A fair range of interested parties have been discussing how they want to see things change. Naturally, for those of us who have lived with it for eleven years, a lot of this discussion has been about IR35.

Actually that is a little lopsided: there are many aspects of the tax system that need to be looked at, such as the hundred or more tax releifs you can claim for depending on your income, outgoings and inside leg measurement. However, IR35 is an obvious target, being both ridiculous and onerous in roughly equal measure.

But can I point out that much of that debate is starting from entirely the wrong premise?

Ostensibly IR35 is about ensuring an individual can’t reduce their tax liability by channelling their earnings through a different commercial vehicle and by not being employed by anyone. For example, if you have a company that has made a handsome £700 million net profit, you could potentially pay a £1.2 billion dividend to your Monaco-resident 100% shareholding other half. Leaving aside the minor detail of how you pay a dividend that represents 130% of your net profit, the point is you pay no tax at all on your personal income, perfectly legally. I mean, how ridiculous is that?

Oh, hang on a minute….

OK, so that’s an extreme case but if you think about it, Mr Green actually has a glimmering of a valid argument in his apparently specious assertion that paying lots of tax through his company somehow compensates for his not paying any tax at all on his beer and skittles money – or at least, nowhere near as much as a Brownian economist might think he owes.

My point is that most, if not all of the IR35 debate is about how to level the tax paid by a small business owner compared to an employee doing much the same job. The answer is actually blindingly obvious: the employee needs to pay more taxes to catch up.

Say what?

Think about it. Assume an individual with a not unreasonable potential income of £75k, either as salary or as net profits from their business. And, for the sake of argument, we’ll assume that none of that money is going to be ploughed back into the business for growth or protection against future gaps in earnings.

An employee would pay roughly 39% in tax and a company owner using the minimum salary and dividends option would pay a mere 26%. Clearly unfair chaps, come on, play the game.

But – and I think it’s quite a big but – look at the actual numbers. Against that income, the employee would pay £29,250 in tax. The company owner, however, would pay £32,625. That’s £33,75 more than the employee does.

Sorry?

It’s because the company owner would also have generated £13,125 in VAT (or £15,000 from January 2011 if you want to be really pedantic, which makes the gap even wider). And since it’s all about income for the Exchequer, the only possible conclusion is that to achieve a level playing field, personal taxation for employees needs to go up by some 13% to ensure they are providing the same level of tax income as the business owner.

Unfortunately I don’t think that is on Mr Osborne’s radar.

Anyhow, I’ve said it before and I’ll say it again; if I’m a tax avoider I’m clearly a very bad one. It really is about time we forgot all about Labour’s stupid notions of fairness and applied a bit of objective thinking to the whole debate. We money-grabbing contractors may take home more than many employees, but we do so by taking much greater risks with our income than an equivalent employee. At the same time we put a lot more back in to the economy.

And after eleven years of IR35, it would really be nice if people began to understand what it is they’re talking about.

Alan Watts can found at LinkedIn.
© 2010 All rights reserved. Reproduction in whole or in part without permission is prohibited.

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You may recall a while back that Arctic Systems was major news. A case that was taken all the way to the House of Lords where, to the great relief of many, HMRC’s assertion that a husband and wife could not share the profits of their company was comprehensively thrown out. S660a does not apply between spouses; end of. So I was more than a little surprised to read this week that HMRC had just lost another S660a case on appeal.

So just what the hell is going on?

The difference between Arctic and this later case – Pattmore vs HMRC – is to a rational mind utterly trivial. Whereas in Arctic the shares were identical, in Pattmore they were non-voting shares. In other words, they were purely a source of income for the spouse. This, it seems, warrants prosecuting the Pattmores under S660a and demanding they pay £20,000 more in taxes.

Luckily, the judge at the Tier 1 Tribunal ruled that the circumstances of the share ownership did not fulfil the criteria for an S660a settlement. Therefore Mr Pattmore was not liable for the tax HMRC said he owed on Mrs Pattmore’s dividend income. Gosh, who’d have thought it…

OK, so good news for the Pattmores, but slightly more worrying news for the rest of us small businesses. That HMRC feel they are justified in pressing this case in the face of a very solid ruling from the highest court in the land almost beggars belief.

I don’t know about you but I thought that HMRC’s duty was to collect taxes owed in line with the legislation in place. Not to chance their arm pressing a case that any sane person would have thought impossible to win, and one that would seem to be vindictive at best.

However that is not the only concern. In the last budget, Osborne raised the spectre of a General Anti-Avoidance Rule, or GAAR for short, which aims to simplify the boundary between acceptable and unacceptable avoidance. Now this might be something worth doing if it is to be applied consistently and fairly and if the boundaries are clearly defined. The bit that worries me is that phrase “applied consistently”: I really don’t have a lot of faith that an organisation that would bring the Pattmore case should be entrusted to apply what would be a largely subjective assessment. And come to that, an assessment that almost certainly would be disputed and so need a court case to establish the answer. Déjà vu, anyone?

And finally, just to confuse things even further, there are mutterings in the press about HMG relaxing their stance on avoidance in general. No idea what that means yet, but we will no doubt find out soon. If true, it would be welcome; there are far more worthy targets than UK’s 4.2 million freelance workers.

But the obvious conclusion to my mind is that Mr Osborne needs to look at the mindset of HMRC very carefully before he starts giving them something as potentially dangerous as the GAAR to play with. Hector needs to re-learn what he is there to do. Chasing un-winnable cases is not it.

Alan Watts can found at LinkedIn.
© 2010 All rights reserved. Reproduction in whole or in part without permission is prohibited.

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Contractor accountants and limited company contractors might be interested to hear that HMRC has lost their case against a couple who it claimed owed nearly £20,000 tax on four years’ dividends.

The Revenue took the Patmores to court under s660a of the Income and Corporation Taxes Act 1988 but Barbara Mosedale, the tribunal judge, decided that when Mr Patmore paid dividends to his wife this was not an s660a settlement.

In the 1990s the Patmore’s bought a small manufacturing company for £320,000. The first payment of £100,000 was obtained by taking out a second mortgage on their home.

Their accountant advised them to reorganise the company shares into two classes, of which Mrs Patmore owned 2% of the A shares and 10% of the non-voting B shares. Dividends were paid on the non-voting B shares between 1999 and 2003 and this money was paid into Mr Patmore’s loan account to be offset against the purchase price of the company. HMRC’s case was that Mr Patmore was using his control of the company to award large dividends to his wife as a tax saving scheme but that she never received any of them as the money went straight into the loan account.

In court, the couple’s adviser said that the two tier share structure meant the couple did not need to pay dividends to Mr Patmore and it also reflected that although Mrs Patmore was not involved in the daily running of the company, she was at risk because of the mortgage liability.

The judge noted that the accountant had set up the company structure in a tax efficient way but this was not a significant factor in the case. She also stated that the Revenue had not taken a broad and realistic view of the circumstances. Whilst HMRC had accepted that Mrs Patmore shared joint and equal responsibility for the repayment of loans to buy the company, it did not register that this arrangement would mean she was entitled to half of the share capital and a fitting share of dividends.

Mosedale ruled that the way the Patmore’s bought their company was “a constructive trust in Mrs Patmore’s favour” and not a settlement under s660a as the Revenue had first claimed. The 10% of non-voting B shares were not a gift and they did not fully reflect her investment. The judge also stated that Mr Patmore held in law the 40.5 shares that his wife should have been entitled to but these were in trust for her.

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