Iain Rankin shows how spouses can benefit from splitting company shares, as well as the traps to avoid.
Many one-man companies utilise their directors’ tax-free allowance by paying them a small salary. With proper planning, the director incurs no income tax or National Insurance contributions (NICs), while the company receives corporation tax relief.
Directors can duplicate this process with a non-earning spouse, gaining tax relief on two salaries. For the spouse’s salary to qualify as a company expense, they must take an active role in the business and cannot receive a wage purely for their marital relationship; otherwise, the tax relief could be invalidated.
The workaround?
By transferring company shares, both partners can withdraw excess profits as dividends, enjoying lower tax rates without incurring NICs. Importantly, shareholders are not required to perform company duties to earn dividends.
Playing by the rules
Anti-avoidance rules (ITTOIA 2005, Pt 5) provide that if a spouse’s income arises from a ‘settlement’, it is deemed to be the income of the other spouse. If one spouse receives income for activities carried out by the other, this rule applies.
It does not apply for: (1) unmarried, cohabiting couples; or (2) married couples where the income arises from an ‘outright gift’ (i.e. not subject to conditions, or reclaimable) (ITTOIA 2005, s 626).
There are two additional conditions for the exception to apply: (a) the gift ‘must carry a right to the whole of the income’; and (b): the gift ‘is not wholly or substantially a right to income’.
Example: Husband and wife company
An historic case, Garnett v Jones [2007] UKHL 35, scrutinised the above exceptions in detail.
Mr Jones purchased a new company, splitting the shares 50/50 with this wife. While Mr Jones carried out consultancy work, Mrs Jones handled minor administrative tasks. Both received low salaries and high dividends.
HMRC argued that the income constituted a settlement, being taxable to Mr Jones under ITTOIA 2005, s 624.
Mr Jones argued that the transfer of shares was an outright gift, and the aforementioned rule in ITTOIA 2005, s 626 didn’t apply.
Ordinary shares
Mr Jones ultimately won his case at the House of Lords; although the gifting of shares represented a settlement, the exception applied as the shares were ordinary shares, constituting an outright gift.
Companies may distribute ‘alphabet’ shares, which restrict shareholders’ voting rights, and/or their right of income to dividends or capital on winding-up. Gifting such shares could be argued to be substantially a right to income and would not meet the criteria for the exceptions; ITTOIA 2005, s 626 would apply.
Waiving dividends
If one spouse receives a variable second income, a 50:50 split is no longer tax-efficient, and adjusting their shareholding is an inadequate solution. Theoretically, dividends could be waived to allow the other to withdraw more dividends.
A deed of waiver must be properly executed, signed by the shareholder and witnessed, before being returned to the company. The waiver must be in place before the dividend is paid. Proper planning is advised, as HMRC may challenge any waiver that is not made for a real business benefit.
In summary, while the Garnett v Jones case declared an open season for company ‘share splits’ between spouses, HMRC will challenge more complex arrangements. Since parts of ITTOIA 2005, Pt 5 use broad terminology, it is best to consult a professional, particularly if your situation is nuanced. Strategise effectively, or risk paying your tax savings right back to HMRC.
Practical tip
Share splits are most tax-efficient when one spouse is non-earning, but if you and your partner have multiple income streams, strategising can become more complicated and it is recommended that you consult a tax adviser.
