THOUSANDS of Britain’s smallest companies are threatening to quit the country over the growing number of tax regulations heaped on them. Evidence from accountants and lobby groups shows that the combined threat of two controversial tax avoidance measures is proving too much for many small enterprises.

Both IR35 and Section 660 — the so-called married couple’s tax — have thrown entrepreneurs into uncertainty about their tax situation and left many with unexpected tax bills running back years.

Now accountants are predicting a brain drain as small companies of all types — from doctors to computer consultants and nannies — leave Britain to set up in a country free from the threat of these onerous regulations.

“Small companies are dealing with a two-pronged attack from the Inland Revenue,” says Anne Redston, tax partner at Ernst & Young, the accountant. “A small business now could find itself hit with IR35 one year and the next year receive a huge tax bill going back several years because they have been targeted under the Section 660 legislation.

She has dealt with several clients who have been driven to countries including Holland and Germany where there is no arrangement like IR35. Separate research from Shout 99, the group that represents freelancers, found that as many as one third of Britain’s small company owners are considering a move abroad.

Susie Hughes, of Shout 99, says: “Businesses are frustrated and angry at the mixed messages coming from a government that professes to encourage flexibility in business and entrepreneurship, but then introduces a succession of new tax rules to hit precisely those people.”

Both IR35 and Section 660 are designed to prevent tax avoidance. IR35 seeks to clamp down on “disguised employment” by people selling their services to clients via a service company or partnership.

Under Section 660, the Revenue is seeking to prevent the transfer of income-earning assets from a higher-rate taxpayer to a lower-rate taxpayer to avoid tax. It is targeting firms in which profits have been paid as dividends between shareholders and seeking to treat these dividends as income of the main worker to be taxed at his higher tax rate.

Businesses complain not only about the regulations but also the uncertainty they have created. Because there is no statutory definition of “employment” or an “employee”, businesses are forced to rely on case law and expensive specialist advice to find out whether or not IR35 will affect them.

Companies and accountants were taken by surprise by the Revenue’s decision to use Section 660 to target husband-and-wife businesses. Previously, sharing dividends between married partners had been an acceptable method of tax planning. The Revenue, they say, moved the goalposts without any warning.

Setting up abroad is one obvious answer for firms struggling under the burden of these new rules, but advisers warn business owners to think carefully before taking such a radical step. Francesca Lagerberg, of Smith & Williamson, the accountant, says: “What the business owner stands to gain from avoiding the threat of IR35 and Section 660 he may well lose through the other forms of taxation in the country that he moves to.”

Working on projects abroad, rather than moving overseas completely, may be the best solution for many business owners, Ms Redston says. “In many cases, people running companies in the UK and working on short projects abroad can escape the national insurance charge of IR35 and pay only the additional tax charge under it,” she says.