In my last column, I took a look at those aspects of the Chancellor’s pre-Budget report that I considered to be of greatest direct or indirect relevance to financial advisers. There were no specific pronouncements on inheritance tax or trusts. However, there were some on pensions which I summarised.I closed the article with a reference to the discussion document on the taxation of small businesses. That this document has been published is probably unsurprising in light of recent publicity given to the Arctic Systems case concerning the tax treatment of dividends paid to a shareholding spouse of a “main contributor” to a business and continuing uncertainty over the application of the settlements legislation when dividends are paid to a shareholder (usually one of a married couple) who, in the Inland Revenue’s view, does not adequately contribute to the business. I will cover this subject in some detail in a subsequent article but, in the meantime, those of you who have not read the discussion document might appreciate the following extracts, which may give some (possibly unwelcome) insight into Government thinking.”The creation of HM Revenue and Customs presents an opportunity to look at the way small businesses interact with the tax system more strategically. The Government believes this paper provides the starting point for discussion with interested parties, focusing particularly on the strategic issues raised by the approach in the tax system towards self-employment and the remuneration of owner-managers of small incorporated and unincorporated businesses.” One conclusion that could be taken from this statement is that there is interest, in official circles at least, in taking a substance over (legal) form approach to the taxation of small owner-managed businesses. The implication could be that the Government sees no difference between incorporated and unincorporated owner-managed businesses.”Evidence suggests that there is a range of factors that underpin any decision to incorporate a business. The Government believes the choice of legal form that a small business takes should reflect commercial rather than tax considerations. In Budget 2004, the Government expressed its concerns about the increasing numbers of self-employed individuals adopting the corporate legal form for tax reasons rather than as a step to growth, often as a result of marketed tax-avoidance schemes. The Chancellor therefore introduced a 19 per cent minimum rate of corporation tax where profits are distributed to individuals by way of dividends, in order to target low tax rates more accurately towards small businesses that reinvest their profits for growth. The Government will continue to monitor this area to ensure its objectives for the tax system continue to be met.” This could be seen as further evidence of official attraction to a substance over form basis of taxing small owner-managed businesses.”The tax treatment of dividends, whether received by an individual who effectively controls the company and works for it as a director, or by unconnected shareholders, reflects the assumption that the dividends are a return on the shareholder’s investment in the company (as distinct from earnings which are a reward for labour).” Especially in the light of the settlements attack and the Arctic Systems case, this looks very much like an expression of an official view that sees a dividend paid from an owner-managed company as “disguised remuneration” or a “remuneration alternative”.”Although the tax treatments of personal income and company income are consistent with the underlying relationships between businesses and individuals, a range of different interactions can arise between the taxes at the small business level which can give rise, in some cases, to apparent anomalies. The interactions between the taxes can also have an impact on behaviour – as has been seen in the trend in tax-motivated incorporation. Yet the tax effect of the various legal structures is not as straightforward as common perceptions suggest. The tax treatment under each legal structure will vary depending on the circumstances of the business.” More of the same possibly. Finally, from the conclusions:”As can be seen from the above examples, the interaction of the personal and corporation tax regimes can create different results for different legal forms and behavioural responses can vary accordingly. In some cases, these reflect genuine commercial differences but in others there may be a strong element of tax motivation.” “The examples illustrate that the tax effects of the various legal structures are not necessarily straightforward as they can vary depending on the specific circumstances of the business. The Government is concerned to ensure that entrepreneurs and their advisers are fully aware of the implications of adopting specific legal structures. “The issues raised in these examples may suggest there are underlying tensions in the tax system. In looking at these tensions, the Government will want to ensure that the tax regimes strike the right balance between promoting enterprise and growth and ensuring that everyone pays a fair amount of tax and National Insurance contributions. “The current system can offer real benefits to a growing company by enhancing the post-tax return on early year profits. At the same time, to a hard working individual who has chosen to remain self-employed, the rules can in some circumstances appear to be giving an unfair advantage to those who have adopted company form for purely tax reasons. The Government wants to ensure that incentives for growth and enterprise do not come to be seen as unfair to others or unduly costly to the Exchequer.” I don’t know about you but I have a nagging sense of foreboding about the Treasury’s ideas on the future taxation of dividends paid to owner-managers by their companies.