Taxing profits could affect your ability to pay school fees

Hundreds of thousands of family businesses face the prospect of paying more tax thanks to a statement hidden away in last December’s Pre Budget Report. To those who have followed the “Arctic Systems” case, this comes as no surprise.

For some years, HR Revenue and Customs (HMRC) have been attempting to charge a family company tax on earnings which it claims are attributable to one partner, but paid to the other in order to minimise tax by keeping the principal’s income below the higher rate tax threshold.

Last year, HMRC finally lost its case in the House of Lords, so it has had no alternative but to change the law – thus frustrating the will of the courts – so that it can look beyond actual remuneration to determine who contributes what towards a business and thus what they should be paid.

HMRC argues it is unfair that some people can reduce their tax liability by shifting income between them; others might argue that with a massive and growing tax burden, everyone should do what they can to reduce their own bill! Certainly, businesses now face the prospect of Tax Inspectors asking how much work, and of what nature, people do in family companies, so that they can effectively tax what they see as the ‘main earner’, even if money is actually paid to a ‘supporter’.

For companies constructed with equal shareholdings between husband and wife, this has further ramifications, because dividends will be included in the calculation. This is likely to mean that, whereas previously dividends could be paid in order to minimise national insurance costs, this may no longer be practical; or at least not without incurring additional income tax liabilities on one partner.

One solution will undoubtedly be to consider making increased pension contributions in respect of the ‘main earner’. Not only are these fully allowable as a business expense, but they also do not attract national insurance on behalf of employer or employee. It may be difficult to do so in respect of the ‘supporter’ – at least beyond a fairly basic level – because the Tax Inspector can disallow pension contributions where it feels the total remuneration package is above what may be considered a market rate for the work done.

However, the benefit of making pension contributions in respect of the ‘main earner’ is that not only will this help build up future retirement benefits but, for a person aged 50 or more (rising to 55 in April 2010) it is now possible to take 25% of the money invested as a tax free lump sum, leaving the rest to roll up or produce a taxable income, as required.

Increased pension contributions can be a highly tax-efficient and effective way of funding school fees.

If you require any further information about the services that we provide or would like to review your financial planning position, please contact us

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