Humphrey & Co remind all business clients that new rules for capital allowances, originally announced in last year’s Budget, came into force last month (April). Most importantly, there is a new ‘Annual Investment Allowance’ (AIA) which will allow traders to claim 100 per cent first-year allowances for most purchases of machinery, equipment and vehicles, to a ceiling of £50,000 a year. As usual, the principal exception is motor cars.

The new AIA is available for purchases on and after 1 April 2008 for companies and 6 April 2008 for sole traders and partnerships. However, it is essential to note that this does not mean that every trader can immediately purchase £50,000-worth of new equipment that will qualify for the 100% allowance. This is because, where the trader’s accounting year spans 1 April or 6 April, the allowance for that year is reduced proportionately. For example, if a company’s accounting date is 30 June, the ceiling on expenditure in the three months 1 April to 30 June, which will qualify for the 100% AIA, will be (3/12 × £50,000 =) £12,500.

It is not necessary to claim the full 100%, for example if you have insufficient profits to cover the allowance, but the balance carried forward will qualify for writing-down allowances only at  the new, lower, rate of 20% a year (hitherto 25%).

As you may recall, last July the long-running Arctic Systems case was brought to a final conclusion by the House of Lords deciding that, where husband and wife are shareholders in a family company, each is taxable on the dividends he or she receives, even if one spouse does most or all of the work which earns the company’s profits. In Arctic Systems itself, husband and wife were equal shareholders in a company, through which the husband conducted his full-time business as a freelance computer programmer. The wife’s input was limited to part-time administration and support. The Revenue claimed that all the dividends, whether paid to the husband or the wife, should be taxed as the husband’s income, because he had earned the money, but the House of Lords rejected this argument. The real point at issue, of course, was that splitting the dividends between husband and wife meant they were all taxed at the basic rate, whereas allocating them all to the husband would have created a higher rate liability.

The Government immediately announced that the Finance Act 2008 would include legislation, effective from 6 April 2008, to reverse the House of Lords decision. A draft of the proposed legislation was published in December, which gave a name to arrangements which allow money earned by one spouse to be split, for tax purposes, between both: it called them ‘income shifting’. It was designed to cover not only family companies, but also business partnerships between family members.

The basic principle of the proposed legislation was that where, as in Arctic Systems, the spouse who actually earns the money sets up or agrees to arrangements which ‘shift’ part of the profits to the other, those arrangements should be effective for tax purposes only to the extent to which the ‘shifted profits’ represent a reasonable rate of reward for the recipient’s contribution to the business. That input might be by way of working in the business, or providing capital, or guaranteeing the business overdraft.

The more or less universal reaction to the proposed ‘income shifting’ legislation was that it would be completely unworkable. Under self-assessment, people must put precise figures on their Tax Returns, but there could be endless argument and debate about what somebody’s contribution to a business is ‘worth’. For example, the Revenue view is that there will be a local ‘going rate’ for people employed to carry out basic secretarial and office administration work – to which the trader would reply that, in a family business context, the ‘support spouse’ is likely to be carrying out a wider, and more responsible, range of duties, so there is no true comparison with a secretary or administrator employed by a large organisation. At the end of the day, it is all very subjective.

Even worse is attempting to value a financial contribution. For example, suppose husband and wife jointly own their home, but the wife allows it to be charged as security for the husband’s business overdraft. What is the value, to the business, of the guarantee she has given? The Revenue says that it is the difference between the Bank’s rates for secured and unsecured lending, but that is unsustainable if the Bank would not have lent at all unless security had been given. The guarantee cannot have an ‘open market value’ because, outside a family or other close relationship, people simply don’t guarantee each other’s loans.

As part of last month’s Budget, the Chancellor of the Exchequer announced that, although the Government still intends to press ahead with the ‘income shifting’ legislation, it now accepts that ‘a further period of consultation’ is required ‘to provide clarity and certainty for businesses and their advisors’. Accordingly, implementation has been postponed for one year, until 6 April 2009. Presumably, there will shortly be another consultation paper, explaining how the Government intends to make the penguin fly.

Meanwhile, for 2008/09 the House of Lords decision remains in force and family companies can, with confidence, continue to split their dividends equally between husband and wife.