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Husband and wife’s appeal for hairdressing companies to be treated separately is allowed

Background

Couples can often run similar businesses separately. HMRC can and has viewed these as artificial separations and looks to combine the businesses. In many cases the combined turnover can result in registration – and, obviously for B2C businesses, a considerable drop in profitability where they are unable to increase their prices. Accountants are often asked to advise on these types of family-run businesses.

HMRC’s view is understandable; it sees artificial splits as unfair. As explained in Statement of Practice 4 (1983), legislation was required because:

  • Firstly, unfair competition results from artificial separation because the split businesses, trading below the threshold, do not have to charge VAT on their supplies and may therefore be able to charge lower prices than their registered competitors.
  • Secondly, tax loss accrues to the Exchequer because, in the absence of separation, the whole business would be trading above the registration threshold and liable to register.

HMRC stresses that the purpose is to counter artificial separation, which results in an avoidance of VAT. HMRC will therefore not aggregate businesses unless they are satisfied that the separation is artificial.

HMRC will therefore only make a direction when:

  • the separation is artificial
  • the separation results in an avoidance of VAT
  • the parties involved are closely bound by financial, economic and organisational links
  • the other legal requirements are satisfied.

The statement of practice then goes on to list various ‘circumstances’ which, in HMRC’s view, imply a contrived device set up to circumvent the normal VAT registration rules.

What has happened recently?

In a recent judgement, released on 17 May, the first-tier tribunal (FTT) allowed an appeal against HMRC’s ruling that artificial separation had taken place. The matter was listed as being whether the appellants, Mr and Mrs Belcher, carried on one business in partnership or two separate businesses independently; it was held that on the facts they carried on two separate businesses independently and therefore the appeal against compulsory registration for VAT was allowed, as was the appeal against a belated notification penalty.

Facts of the case

As with all tax cases there were a number of issues (and the full judgement makes very interesting reading) but the basic facts were:

  • The appellants (husband and wife) both ran hairdressing shops from their home. The house had been converted so that the husband had a shop within the house and the wife had a shop in the garage.
  • The husband did not get involved in his business (a barber’s shop) but employed other people to provide the service. The wife had formal training and was involved in her ladies’ salon.
  • The wife handled the accounts of both the barber’s shop and the ladies’ salon.
  • The net takings from the barber’s shop and the ladies’ salon were banked in a bank account held jointly by the couple (either a private or business account) and were effectively shared by them on a 50/50 basis.
  • Both businesses were included as one in a partnership return, with both spouses named as partners.

HMRC’s viewpoint

HMRC’s opinion was that the two businesses were in reality one. The self-assessment (SA) returns for the tax years 2004/05 to 2013/14 were used by an HMRC ‘hidden economy’ officer to calculate an estimated VAT liability of £136,691.26. The stated reasons behind HMRC’s viewpoint were:

  • The partnership SA return is for one business: Crewe Cuts (the overall business name).
  • The partnership annual accounts are for Crewe Cuts.
  • Both businesses share business rates and utilities.
  • Crewe Cuts has one telephone number for customers.
  • Monies from both businesses are pooled at night and placed into one business account.
  • Purchases for both businesses have one supplier’s account.
  • The partnership (husband and wife) split profits 50/50 on the SA returns.

Interesting points

The notes on the judgement are detailed but some points can be picked out as particularly interesting:

1.     HMRC’s offices agreed (under cross-examination from the appellants’ representative) that in two instances they had not followed the instructions from their own internal staff manual.

2.     The issues were noted as being very fact-sensitive and therefore other tribunal decisions, which had been cited during the case, were not found to be of determinative significance.

3.     The fact that partnership SA returns were filed for a number of years was noted as an indication that in fact the appellants were carrying on a single business as a single taxable person. However, the judgement went on to state: ‘having seen Mr and Mrs Belcher, and heard their evidence, we accept on the balance of probabilities that they did not know or understand the import of their submission of self-assessment income tax returns on the basis that they were carrying on a single business in partnership.’

4.     The judgement accepted the evidence of Mr and Mrs Belcher that they did not divide the profits of a single business between themselves on a 50/50 basis, but pooled, as a family matter between husband and wife, the net profits of two businesses into one or more joint bank accounts.

Conclusion

This very interesting case highlights the difficulties in deciding on the facts of artificial separation. It does show that the tribunal maintains an independent viewpoint and will look at the facts of each case.

Businesses should always refer to HMRC’s internal manual and the Statement of Practice 4 (1983) when considering this issue so that they are clear on the current position of what may or may not be accepted.

Note that HMRC has the right to apply for permission to appeal against the judgement and has 56 days to do this. Watch this space for further developments!

Article from ACCA In Practice