At McDade Roberts we help many different business structures and individuals with their tax and accounting needs. One segment we help are husband and wife businesses. HM Revenue & Customs (HMRC) has shown great interest in businesses where both spouses are owners (either as shareholders or partners) but one spouse is considerably less active within the business than the other.

Their focus is “settlements legislation” which HMRC will seek to apply where one spouse (the settlor) enters into an arrangement to divert income to the other spouse and in the process tax is saved.

On the face of it, all transfers between husbands and wives could potentially be settlements. However, there is a statutory exemption where property passed to a spouse is an outright gift, unless

• the gift does not carry the right to the whole of the income arising (i.e. income could still be payable to either spouse), or

• a gift between spouses is wholly or substantially a right to income

The legislation is not new, but was originally enacted in the 1930s and brought up to date in the 1990s.

Legal testing

It is helpful to consider the basic situations which may involve income shifting:

• Main earner drawing a low (non-commercial) salary leading to enhanced profits from which dividends can be paid to spouse shareholder.

• Differing classes of shares enabling dividends to be paid only to spouse paying lower rates of tax.

• Dividends being waived so that higher dividends can be paid to spouse paying lower rates of tax.

• Dividends paid on shares that carry only restricted rights.

Income shifting is less likely to be in point:

• If the shares have considerable capital value

• If the main earner draws a commercial salary before dividends are declared

If income shifting is proven:

The income of the lower taxpayer is taxed as income of the donor of the gift (the settlor).

Prevention Strategies

• A stronger position may be created if husband and wife both subscribe for shares when the company is formed and both are directors from the outset

• Make sure all shares carry voting and capital rights

• There is an argument for husband and wife receiving equal directors’ fees rather than salaries and therefore not being employees, particularly if this is evidenced by a commercial agreement

• The position is also strengthened if husband and wife receive equal dividends

• Aim to have the “non-earning” spouses involved in the business as much as is practical, thereby giving full value for any money received

• A company with substantial assets which generate income, or retained profits, is not so likely to be caught

Do you run a husband and wife business and want to make sure that you are set up correctly? Feel free to contact us for a no obligation chat and we will happily help.