The taxman asked the Law Lords today to overturn a business couple's ground-breaking court victory which could cost an estimated £1 billion a year in lost revenue.

IT consultant Geoff Jones and his wife Diana, of Broomershill Lane, Pulborough, took on HM Revenue and Customs (HMRC) six years ago when he received a £42,000 tax demand over and above his usual assessment.

When Mr Jones, 50, finally won his case at the Court of Appeal in December 2005, he believed he had struck a blow for small family businesses throughout the country.

There are believed to be 30,000 other firms run by couples who could save on their tax bills by taking more income in the form of dividends rather than salaries.

Mr and Mrs Jones both took out a small salary as well as a dividend, which was split equally between them.

But today Michael Furness QC, representing HMRC, told a panel of five Law Lords who sit at the House of Lords that the scheme operated by the couple was not permitted under tax regulations.

He said Mr Jones, 50, drew an "inadequate" salary from his company, Arctic Systems, which led to it having "excessive reserves".

These reserves were then used to pay "excess" dividends to Mrs Jones, who had a 50 per cent share in the company where she was the business manager.

"This meant that Mrs Jones was effectively sharing income with Mr Jones and as a result the arrangement involved an element of bounty."

Under tax regulations, this meant that Mr Jones should be assessed in the entirety of Mrs Jones's dividend income, he said.

Mr Furness asked the highest court in the land to uphold his appeal.

He said: "Permitting such arrangements would be tantamount to facilitating for these couples whose circumstances allowed them to take advantage of it, a new form of voluntary joint taxation, albeit one much more favourable than the old system of single taxation of husband and wife."

The Professional Contractors Group, which funded the case for the couple, estimated that the victory in the Court of Appeal would cost the taxman £1 billion a year.

A tax tribunal and the High Court had accepted the HMRC argument that the couple's tax avoidance set-up broke the rules.

But High Court Chancellor Sir Andrew Morritt, who gave the judgment in the Court of Appeal, said that although only one spouse may be generating income, the services of the partner may be just as commercially important to the company.

The appeal at the House of Lords is expected to last three days.

The Federation of Small Businesses (FSB) later issued a statement attacking the HMRC decision to pursue the case.

Bill Knox, FSB Taxation Chairman, said: "HMRC's conduct towards a family-run business in this case is utterly shameful."

He added: "Hounding hardworking small business owners in this way sullies the good name of HMRC and will not instil confidence in the UK small business community as a whole, which rightly expects to be treated proportionately and fairly by the tax authorities.

"The craven decision to pursue the case further will be at the expense of the taxpayer and will result in a damaging loss of confidence in HMRC's record with small businesses."