Lee Sharpe looks at one of HMRC’s key tools to combat income transfers between couples in the second of a series of articles.
This is the second in a series of articles that will look at the so-called ‘settlements regime’ – the settlements anti-avoidance legislation; how it applies; and how to avoid it in the various scenarios that a property owner is likely to encounter.
In the first article, I looked at why people might want to transfer property interests and what would be the implications if the settlements regime were to bite. In this article, I’ll be focussing on how the regime applies in relation to transfers between spouses and civil partners.
Scope of the regime
The fundamental aim of the regime is to tax income that a person (the settlor) has ostensibly diverted to another party, but from which that person may yet benefit. The legislation effectively assumes that this will apply if:
- the settlor;
- the settlor’s spouse or civil partner; or
-
the settlor’s minor children (strictly, children under the age of 18 and who are unmarried)
may benefit from the diverted income. In essence, if the diverted income may benefit the settlor’s household, it will likely be ‘caught’ by the anti-avoidance regime. This makes sense, as the regime would not be much of a barrier to diverted income for income tax purposes if a person could, for example, say simply “pay my rental fees to my husband instead”.
But this approach does, in turn, run up against the notion of independent taxation – in other words, that the wife’s income belongs to and is assessable on her rather than on the husband on her behalf.
Over 30 years ago, when the then-Chancellor Norman Lamont was debating the 1989 Finance Act, he said:
“Independent taxation [of spouses and – now – civil partners] is bound to mean that some couples will transfer assets between them with the result that their total tax bill will be reduced. This is an inevitable and acceptable consequence of taxing husbands and wives separately.”
So, how does the settlements regime still figure?
Spouse (or civil partner) exemption
ITTOIA 2005, s 626 contains what is commonly referred to as the ‘spouse exemption’, which states that a gift of assets between spouses or civil partners will NOT be caught by the regime if, simply put:
- it is an outright gift (meaning an unconditional gift from one spouse or civil partner to the other); and
- the gift includes a right to all of the income arising on the transferred property; and
-
the gift itself is not essentially a gift of income.
So, for example, a civil partner cannot give away 100% of a rental property to the other civil partner and then say, “but you may have only 40% of the income, as I want to keep 60% for myself”. This would not be gifting all the income that arises on that property.
Nor can one spouse say to the other, “I want to give you (say) 70% of the income from my rental property but I want to retain 100% of the ownership of it”. This would effectively be a gift only of income.
Spouse exemption in action
The tax case Jones v Garnett [2007] UKHL 35 involved an IT contractor who ran a limited company; his wife was a fellow shareholder but the husband undertook the contracting work. The company was quite profitable and both spouses enjoyed substantial dividends from their shares in the company. HMRC argued that the settlements legislation applied; Mr Jones had let his spouse have shares in ‘his’ company and benefit from dividend income, on terms that would not have applied outside of close family.
The House of Lords agreed – there was a settlement. Crucially, however, they held that Mr Jones’ settling of shares in favour of his wife fell within the scope of the spouse exemption; it was a transfer between spouses; there were no conditions attached and the shares did not comprise ‘only’ a right to income (the shares had voting rights, and capital rights, such as on a winding-up of the company).
This highlights an important practical point; just because there is a settlement of property (in this case, a settlement of a share to one’s spouse), this does not mean that the anti-avoidance legislation will be triggered.
Take care: assets held by spouses or civil partners in joint names
In this context, I mean assets held in joint names – such that, with land and buildings, both names should be noted on the Land Registry, etc. Usually, tax is concerned only with beneficial ownership of the property; but where property is held in joint names between spouses and civil partners, tax law automatically assumes that the income from the property will be split 50:50 (ITA 2007, s 836).
This can be helpful in some cases but less so in others, such as where the higher-earning spouse wants to transfer significantly more of the potential income to the lower-earning spouse. Where this is the case, and the property is held in joint names, the income split will normally have to follow the underlying split in beneficial ownership – and only once correctly notified to HMRC using the Form 17 procedure.
There are several examples in its Trust and Estate manual (see TSEM9920), including the following:
“A flat is rented out and the rents are paid to A. A claims that the rent from the flat should be taxed half and half on A and her husband B. A says she has transferred the flat into joint names with B. But the Land Registry record clearly shows that A is the sole owner. It is also established that she was the sole borrower of the loan from the building society [so it is difficult for the taxpayers to argue that the husband has, in fact, acquired a beneficial interest in the property by helping to finance its acquisition].
There is no evidence that the beneficial ownership of the property or the income is held to any extent by B.
Joint ownership is not in point here. The property is not held ‘in joint names’, so… A is taxable on all the income.”
Beware of transferring only income
Aside from the specific caveat in the settlements regime regarding the spouse exemption and transferring something which is wholly or mainly a right to income, there are also anti-avoidance provisions which can apply beyond the narrow focus of transfers between spouses or civil partners.
The ‘Transfers of income streams’ legislation (starting at ITA 2007, s 809AZA), is aimed at attacking something which is effectively the disposal of an income stream to another party (and which does not include any transfer of the underlying income-generating asset), as income still ‘belonging’ to the transferor.
Conclusion
I have considered the ‘spouse or civil partner exemption’ available in the settlements anti-avoidance regime and how it broadly acknowledges the independent taxation of spouses, etc., by preventing the regime from attacking the income arising from straightforward, unconditional gifts of capital assets from one spouse to the other.
In the final part of the series, I will look beyond transfers between spouses and civil partners to other relationships, such as children – young or old.
