The government has dumped legislation intended to overhaul income splitting arrangements among individuals that would have effectively forced small, family-run businesses to pay more tax.

In an embarrassing U-turn, Chancellor Alistair Darling said during his pre-budget speech on Monday that Her Majesty’s Revenue & Customs (HMRC) would indefinitely delay bringing in the new law.

Legislation to prevent spouses divvying up income earned from small businesses solely to reduce their joint tax bills had been expected at the start of April 2009.

HMRC estimated in January this year that some 85,000 companies throughout the UK were currently working the system to their advantage.

The loophole was brought into sharp focus in July 2007 when Arctic Systems beat the taxman, which had pursued the small, family-run IT services firm for what it claimed was unpaid taxes.

The government responded by announcing an overhaul to the system after the House of Lords threw out an HMRC appeal against the practice in favour of Arctic bosses and married couple Geoff and Diana Jones.

"Given the current economic challenges, the government is deferring action and will not bring forward legislation at the finance bill 2009", said the Treasury on Monday.

Darling also announced that the government will make available £1bn for small businesses in need of funds. Seven UK banks have asked for access to the £4bn offered to SMEs by the EU. Small exporters will get help with an extra £1bn via Export Credit Guarantees.

Smaller firms will also be able to spread their tax payments, not just VAT, over a longer period. ®

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