If the answer is yes to any of these questions, then you and your company may be now be the subject of an Inland Revenue enquiry - which, at best, will be a nuisance, and at worst extremely expensive.

Such enquiries can generate high legal or accountancy bills and interest on underpaid tax going back several years and also probably give rise to penalties.

So how has this situation been brought about? The answer is April's landmark High Court decision, the Arctic Systems case, which has overturned standard tax planning advice previously given, not only by lawyers and accountants, but even by Business Link - the support agency run by the Department of Trade and Industry.

The Business Link guidance did not suggest deliberately diverting income from higher rate taxpayers to other family members, so as to save on tax, but it did suggest that family members' pay might be "topped up" through dividends, pointing out that shareholdings between husband and wife are "a perfectly acceptable way for them to do business".

But with the Arctic case, all this has now changed.

A family and its company were taken to court by the Revenue, using legislation that has been with us since the 1930s. Amidst much controversy, the Revenue won its case and has now issued guidance on situations where the taxpayers' arrangements may be attacked.

Arctic Systems was an IT company, run by husband and wife, Geoff and Diana Jones.

They acquired one share each when the company was bought "off the shelf".

Geoff Jones was an IT consultant and was the only director of the company. Diana Jones dealt with the company administration and was company secretary. They were each paid a small salary. This is a common situation, affecting family companies in many types of business.

Made a 'settlement'

The Revenue decided that, as Geoff Jones was the only director, and as he would have expected to earn a much larger salary, he had made a "settlement" under the antiavoidance legislation.

This meant that his wife's income would be taxable upon him and the Revenue promptly issued an assessment for £42,000 for extra tax for the year 1999-2000 and earlier years.

Mr and Mrs Jones appealed to the commissioners. The Inland Revenue agreed to drop the claim for earlier years' tax and proceeded on the assessment for 1999-2000. Two special commissioners heard the case and disagreed as to the outcome. The senior commissioner used her casting vote and the appeal was dismissed.

The case went to the High Court. The judge said that the taxpayer, an IT specialist, and his wife each owned a share in a company which earned profits by providing the taxpayer's services to clients. He drew a comparatively small salary so that the company earned profits, distributed as dividends. His wife, the company secretary, received half.

The Inland Revenue claimed that the company structure was a "settlement" as defined in what is now Section 660A Income and Corporation Taxes Act 1988. However, this legislation does not apply to outright gifts.

The judge held that there was not an outright gift, as Mrs Jones had bought her share for £1 when the company was set up. There was a settlement though, because the dividend contained "an element of bounty" - a requirement for the legislation to apply.

In taking a low salary, her husband had increased the company profits, therefore increasing is wife's income.

This income was therefore taxable on Mr Jones as settlor of the "settlement".

As a result of the win, the Inland Revenue has issued guidance on the situations with which it is not comfortable.

Situations which would invite their attention include: a main earner drawing a low salary leading to enhanced profits from which dividends can be paid to shareholders who are friends or other family members (this was the situation in the Arctic Systems case); disproportionately large returns on capital investments (eg excessive rates of interest paid on loans); differing classes of shares enabling dividends to be paid only to shareholders paying lower rates of tax eg A, B, C etc shares, some carrying higher dividend rights than others; dividends being waived so that higher dividends can be paid to shareholders paying lower rates of tax (waivers have to be made before a dividend is declared, so that leaves a higher profit available for distribution to the remaining shareholders); income being transferred from the person making most of the profits of the business to a friend or family member who pays tax at the lower rates (there is specific legislation already in place regarding diverting income to minor children).

Important exemptions

There are some important statutory exemptions from the legislation. Section 660A(6) exempts situations where the property passed to a spouse is an outright gift, unless: the gift does not carry the right to the whole of the income arising, or the property given is wholly or substantially a right to income.

Many of the situations above have long been accepted as legitimate tax planning, but now taxpayers will ignore the Revenue's warning at their peril.

Not all husband and wife companies will be affected. If a husband and wife set up a company and run it together, it does not follow that the husband will be taxed on the wife's dividends.

An important feature of the case was that the taxpayer effectively provided funds for the "settlement" by working for the company in return for a salary far below his true earning power.

This case related to a husband and wife company, but the scope of the legislation is not limited to husband and wife situations, nor only to companies.

Remember the legislation dates back to the 1930s when a married woman's income was taxed upon her husband. It also applies to individuals and trusts.

It should be pointed out that this situation could have been avoided had Geoff Jones been paid a higher salary. It would be wise to pay attention to the warning signs set out above and keep family business transactions within the realms of what the Revenue would class as commercial reality.