Income shifting
One personal tax area that the PBR might cover is income shifting.
You may recall the case of Jones v. Garnett, which HMRC lost in
the House of Lords.
Mr and Mrs Jones set up in business together, which they chose to
operate as a limited company, and both purchased a £1 share in a company
called Arctic Systems Limited. They each drew small salaries and
distributed the majority of their income in the form of dividends, which
unsurprisingly they shared equally given the 50/50 his-and-hers nature
of their share ownership.
What HMRC seemed to find so offensive was that Mr Jones was a higher
rate taxpayer but his wife paid tax at a lower rate. HMRC argued that as
Mr Jones did the majority of the work in the business the dividend
received by his wife should rightly be taxed as Mr Jones's income -
which of course would attract tax at the 32½% rate in his hands. HMRC's
argument was rejected roundly by the House of Lords in 2007.
The 2007 Pre-Budget Report announced that new rules would be introduced
as a direct response to the case. The problem with them was that whilst
their proposals could have worked in very simple cases, there would have
been a administrative nightmare for many other family-owned companies
and partnerships. The Treasury announced at Budget 2008 that the
proposals would be reconsidered; we hope that they will not reappear but
fear that they will.
We would much rather that the focus for personal taxation matters was on
simplification.
If we ruled the (tax) world, one of the first things we would think
about would be realigning the lower earnings NIC threshold and income
tax basic rate band. Doing so would make life much easier for companies,
payrolls, and indeed anyone needing to calculate their annual tax bill.
The two were aligned right up until the furore over the abolition of the
10% tax rate, which lead to the Chancellor uplifting the personal tax
allowance to create tax savings of £120 to people earning less than
£40,000. We can't imagine the Chancellor doing anything other than
making the personal allowance uplift permanent -but will he also raise
the lower earnings NIC threshold to bring them back into line?
Doing so would cost £3.3 billion (remember that there would be savings
for employers as well as employees, as a failure to keep the employer
and employee thresholds the same is unthinkable), so it's not small
beer. The Chancellor could consider aligning the upper earnings NIC
threshold and the higher rate tax band, but the top rate band would have
to increase by around £1,300 before the change was tax neutral. An
alternative might be to increase the rate of employer's national
insurance, or make changes to the 1% employee rate.