03.05.2008 INCOME SHIFING

 I use the word problem advisedly here. In any Self Assessment tax system, taxpayers should be entitled to complete their returns and self assessments with certainty. To leave them floundering around in a miasma of judgemental decisions is not acceptable, yet that is what the intended legislation would have done. All this uncertainty does is fan the flames and leave taxpayers potentially exposed to penalties for filing incorrect tax returns.

As an aside it must be borne in a mind that despite a general principle of not retrospectively legislating for tax, this Government has mastered the art of doing so under the guise of ‘we originally meant the legislation to say this, and so we are making it do so now. This has happened in both the changes on the taxation of trusts when people who had put quite legitimate trusts in place had to review them under new legislation and in the 2008 budget on the use (abuse in their parlance) of Double Tax Treaties where the legislation reaches back to 1987 (21 years!).

The issue of income shifting comes about when for example couples organise their affairs in such a way that typically when running their own company they take a small salary and pay themselves largely through company dividends. Because there is no National Insurance on dividends and because one member of the couple may do more work in the business than the other the thrust of the proposed legislation is to recognise the division of labour and allow the salary and dividends to mirror that effort.

The problem is in for example a corner shop business how does that couple decide that division of effort with the certainty needed under the UK’s tax laws to make their self assessments?

I have several points to make.

Although the start of all of this was against couples, the proposed legislation was much wider than that and potentially affected a much wider target.

The Government has made it clear that a couple who decide to simply share the reward equally as typically happened before will have to prove it. Their rationale for this is that an employee who does not run their own company cannot split their income with their partner. True enough but that is a naïve assessment of a far more complex set of circumstances.

The income splitting couple may have put their house on the line to secure borrowings for the business; a typical employee will not do that. How do you gear that risk into the equation? You don’t, it is conveniently ignored.

Perhaps one member of the couple works longer hours than the other and under the proposed rules should be allocated a higher share of income? Fine but perhaps they can only work those hours because their partner is at home dealing with the kids and writing up the business records. How do you quantify that?

For example, if both parents in a family work outside the home and each earns £30,000 a year, each will pay Income Tax of around £5,000 annually.  If one spouse stays at home, and the other is fortunate enough to earn £60,000 the Income Tax bill is some 60% higher at around £15,750.  Such a fiscal penalty is utterly unjustifiable. Is it any wonder that the couple in business start ‘income splitting’?

Why does HMRC assess on the basis of household income in the field of Tax credits and on an individual basis when it comes to Income Tax? Other than history, there seems to be little rationale for this differing approach. What too about Council Tax, Student Grants etc?

No wonder people get confused.

Why is it only earned income that is a problem? The answer lies in both the National Insurance (NIC) take and the loss of 40% tax. We still have this fiscal fiction in the UK that NIC is a contribution when it is to all intents and purposes a tax. Worse still there are instances when the rules although generally the same for income tax and NIC are misaligned.

Parliament seems to have no difficulty with allowing couples to share income from investments such as share portfolios or let properties. Nor does it have a problem allowing them to arrange their estates for Inheritance Tax. Until fairly recently there was no difficulty either with arranging the sharing of assets for Capital Gains Tax (whereas now we have a limited form of anti-avoidance in relation to CGT adding to the complexity and further uncertainty).

I return to the point that it is simplicity and clarity that is required not the sticking plaster approach of yet more legislation, which in itself will only fuel uncertainty for the hard pressed taxpayer.

Publication:  The Scotsman
Date:  3rd May 2008