Income Shifting - Is a family business tax u-turn on the cards?

Following the Chancellor's recent partial U-turn on Capital Gains Tax, there is now mounting pressure on the Treasury to backtrack on its controversial plans to ramp up tax on family firms in the recently announced income shifting proposals.

Reports in the Mail on Sunday and other publications suggest that the Chancellor is planning to take the sting out of his earlier plans to clamp down on husband and wife businesses.

Income Shifting occurs when a small business apportions income to family members with the overall effect of reducing the joint tax liability of the beneficiaries. For example, a limited company director may distribute half of the company's profits to his wife via dividends (as a 50% shareholder), regardless of how much work his wife may have carried out for the company.

The Treasury has tried to clamp down on 'income splitting' using existing legislation since 2002, however such attempts were dealt a blow with its defeat in the House of Lords over the Arctic Systems tax case, which revolved around a limited company director's right to distribute part of his company's profits to his wife.

The new proposed measures would require all small businesses that pay out dividends or partnership profits to calculate whether the recipients receive a market rate for their contributions to the success of the business.

According to the Mail on Sunday: "Sources close to talks involving the Treasury, business groups and the accounting profession say a rethink on 'income shifting' seems likely to form the centrepiece of a package of measures friendly to small business."

You can keep up with the very latest developments on income shifting via our sister site, Contract Eye.