If you work through a limited company it may be a good idea to give
some shares to your spouse as a tax efficient way of rewarding them
for their contribution to the business. Despite the fuss kicked up by the
Government recently over so-called income shifting, this is still
perfectly legal and there are no plans yet to enact legislation against it.
In fact, the controversial Treasury consultation document released in
2007 in the wake of the Arctic Systems case has been
unceremoniously ditched, having been universally condemned as
completely unworkable, and any further action the Government might
have been thinking of taking was indefinitely postponed in the 2008
pre-Budget report.
Splitting shares with your spouse to save tax on the dividends has
always been a mainstay of effective tax planning for family companies
and was even advocated by the Government's own Business Link
service not so many years ago. It is unfortunate that the current
Government has taken such an ideological stand against this common
practice as it created huge uncertainty and confusion in family
business taxation for 5-6 years after use of the s660A settlements
legislation to crack down on it was first mooted by the Revenue in Issue 64 of its Tax Bulletin in April 2003. However, with the Arctic
Systems ruling in 2007 and the issue now firmly on the back burner,
we do not expect to see any anti-avoidance legislation aimed at family
companies in the foreseeable future.
Notwithstanding this, the legislation under which HM Revenue and
Customs brought the Arctic Systems case was not completely
neutered, and it is important for any husband and wife business to
understand the House of Lords judgement in order to avoid any
potential pitfalls. The case was brought under s660A ICTA 1988
against Geoff and Diana Jones, who had done what every accountant
in the country would have advised their clients to do and split the
shares in their company. Geoff Jones was an IT contractor and the
main fee earner of the business whilst his wife Diana did various
administration tasks at home.
The initial rulings by the Special Commissioners (on a casting vote) in
2004 and the High Court in March 2005 went in favour of the Revenue.
The Court of Appeal then found in favour of the taxpayer in December
2005 and the Revenue appealed to the House of Lords. The Law
Lords gave their unanimous verdict in favour of the taxpayer in July
2007.
Although the Law Lords agreed with the Revenue that a settlement
had been made by Mr Jones to Mrs Jones, the case turned on whether
or not the share she subscribed for was a gift and therefore exempt
under s626 ITTOIA 2005. It was held that the share was a gift, despite
the fact that she paid £1 for it, because it would not have been
transferred to her for that notional sum under any other circumstances.
It was also held to be a gift on the grounds that it was not substantially
a right to income. That is because ordinary shares also confer on
holders the right to vote at shareholder meetings and to participate in a
return of capital if the company were to be wound up.
From a tax point of view, the optimum split of shares between you and
your spouse is that which maximises use of your basic rate bands and
reduces your joint exposure to higher rate tax as much as possible.
This will depend on your other sources of income so there will probably be a certain amount of crystal ball gazing involved, but you can vary
the allocation of shares in the future so your initial split is not set in
stone. To split shares you need to do 3 things:
- complete a Stock Transfer Form and send it to your local Stamp Duty office
- enter the share transfer in your Members register and issue a new share certificate
- enter your new shareholdings on your next Annual Return to Companies House
How much tax can you save by splitting shares? For 2009/10 it could
be anything up to £11,053. Compare the following results for a
company with a) one shareholder and b) two shareholders each
owning 50%:
Not only does the company save 21% corporation tax on the extra
salary but there is no income tax liability at all if dividends are split
between both spouses as they do not exceed the basic rate band. This
assumes that the spouse salary is fully allowable as a trading expense
and that neither spouse has any other income.
Spouse shares also enable you to minimise capital gains tax when you
come to sell or dissolve the company because a) you can make use of your spouse's annual CGT exemption (£10,100 in 2009/10) and b) you
will both get entrepreneurs relief provided you have held the shares for
at least a year. They will also be exempt from Inheritance Tax as they
qualify for business property relief after 2 years.
It is very important to ensure that the share transfer is a gift unless you
are fairly certain that it could not be seen as a bounteous arrangement
under the settlements legislation. As that would almost certainly be the
case where one partner is the main fee earner, you must either make
sure that the shares are transferred as a gift or be very sure that the
dividends they yield will be a fair reward for the added value your
spouse brings to the business. Therefore, your spouse should not
make any payment at all for the shares otherwise you could potentially
still fall foul of the Section 660 rules. To reinforce this, you should enter
Nil as the consideration on the Stock Transfer Form and get it
stamped. The shares must also be transferred free of let or hindrance
and with no pre-arranged conditions, such as a promise to give them
back!
You should also not issue preference shares or restrict the voting
rights or other benefits of owning ordinary shares or you could turn
them into instruments that are no more than a right to income. They
would then no longer qualify for exemption as a gift.
Dividends should not be paid into a joint bank account as this could be
seen as the transferor of the shares continuing to enjoy some benefit
from them. That could then jeopardise their status as a gift.
Note that the exemption for gifts only applies to spouses, not
unmarried partners. However, the settlements legislation does not
normally apply to unmarried couples anyway (hence its derogatory
description as the husband and wife tax) unless the transferor retains
some interest in the gifted shares, so it is important for unmarried
partners not to pay dividends into a joint bank account.
Finally, you should consider appointing your partner as a director (with
no service contract) so there is no chance of falling foul of the
Minimum Wage rules. This is particularly important where you follow the usual low salary and high dividend route and your spouse works
more than say 20 hours a week for the company. It can also reinforce
an assertion that your partner plays a significant role in the company,
although you may need to prove this further by keeping minutes of
board meetings.
