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Income shifting measures could be revived, says OTS Tax Director John Whiting

Contractor’s tax affairs are once again under the spotlight. Measures to tackle income shifting through the so called ‘family business tax’ are on the agenda of the Office of Tax Simplification (OTS), alongside IR35 and National Insurance, according to OTS Tax Director John Whiting in an interview with The Telegraph.

The Telegraph reports that the Treasury believes a clampdown could raise £200m.

But Dave Chaplin, CEO of ContractorCalculator, argues that the reported £200m new revenue that such income shifting rules could raise is minor compared to other areas of tax avoidance. This is something of a side issue,” he believes. “ The Treasury and HMRC would be better focusing their efforts on tax evasion, where the sums are considerably greater and the return on investment much more worthwhile.

“HMRC failed in its last attempt to impose a family business tax because its proposals failed to acknowledge the intangible contributions to a business made by family members, particularly spouses, and would punish millions of small businesses regardless of their activity.”

Income shifting, also known as income splitting, is where husbands and wives, or civil partners, split the income generated by a jointly owned business to make full use of their tax allowances and reduce their tax bills, regardless of who actually generated the income.

The subject hit the headlines a few years ago when HMRC applied tax laws dating back to 1936 to pursue a four-year test case against contractor limited company Arctic Systems. The business was owned by husband and wife team Geoff and Diana Jones, who pursued their case to the House of Lords, which ruled in their favour. Not surprisingly, therefore, Whiting describes income shifting as being in the “pretty-difficult-to-do box”.

Whiting also told the Telegraph that the IR35 rules are “the most intractable issue since the year dot. Clearly we have to come up with some ways forward. I doubt it will be something where we can say, ‘It’s dead easy’. I think a lot of people will be quite happy if we say: ‘This really is a problem. It has to be solved. Here are some ways we can do it: now choose.’”

On IR35, Chaplin agrees with Whiting’s analysis of the difficulties posed in trying to find an IR35 solution: “Our analysis of the current rules demonstrates that they are unworkable and, despite a rigorous examination of alternative options, we’ve concluded that there is no solution to IR35. Focusing on ‘disguised employment’ and measures to tax it is simply a sticking plaster and does not address the root issue.

“The OTS has identified National Insurance Contributions (NICs) as a small business taxation issue that leads to people incorporating and paying dividends,” continues Chaplin. “Combining income tax and NICs and taxing income regardless of how it is earned would be the simple solution to IR35, but would it be the most desirable solution for contractors?”

To coincide with the OTS review of small business taxation and IR35, ContractorCalculator is running a series of IR35 solutions articles looking at the historic context of IR35, its enforcement and possible solutions.

Updated: 22 December 2010

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