Can married couples and civil partners safely reduce their tax bills?

Many business owners are in the privileged position of being able to make tax savings by equalising their income with their spouse or civil partner. Typically they do this by splitting the shareholdings in their company to enable dividends to be paid to a lower earning spouse.

Unsurprisingly, HMRC are unhappy with such arrangements where they are clearly structured for tax avoidance purposes; they have taken a number of cases to tribunal in recent years and have also attempted to introduce legislation to counter such arrangements.

With careful use however, this area of tax planning remains successful.

This blog looks at what is ‘safe’ planning and what is likely to attract the interests of HMRC.

What has been established in the tribunals and courts?

In the Arctic Systems case back in 2007, HMRC tried to argue that a gift of shares from a husband to his (lower earning) wife was a ‘settlement’ and the dividends paid to her should, as a result, be taxed on him, thus removing any the tax savings.

HMRC had been successful in this argument in the 1996 case of Young v Pearce which held that a gift of preference shares, carrying mainly a right to income, was a settlement and the dividends were therefore taxable on the spouse who had made the gift.

However, the Arctic Systems case in fact established that there is a difference between a spouse (or civil partner) being given ordinary shares which carry all the usual rights, or shares which carry only an entitlement to dividends; where they have been given shares with all economic rights attached, any dividends paid should be treated as the income of the spouse who has received the shares and the settlements legislation will not apply.

Immediately after this case, HMRC announced they would introduce anti avoidance legislation to counter income splitting of this nature. However this legislation has never materialised, probably because of extensive lobbying.

For successful tax planning therefore, the rights of shares gifted to a spouse should not be restricted in any way.

What level of dividends can be paid? 

Dividend waivers enable one or more shareholder to waive their dividend entitlement, but problems are likely to occur with HMRC when waivers are used to distribute funds to shareholders on a ‘disproportionate’ basis.

Whilst the transfer of shares to spouses should be safe from HMRC challenge as outlined above, this will not be the case where dividend waivers are then used to provide them with excessive dividends.

Unfortunately, dividend waivers cannot fall within the ‘outright gifts’ exemption which saved the Arctic Systems case, because they are simply a right to income, therefore they can be attacked under the settlements legislation. HMRC have been successful with this in a number of tribunal and court cases and their manuals provide an indication of the factors they will consider in deciding whether the settlements legislation applies to dividend waivers. In essence these factors cover the payment of dividends which would exceed the company’s reserves if paid to all shareholders; where there is evidence to suggest there are tax avoidance reasons for the waiver; or where there are reasons why the other shareholders would wish the non-waiving shareholder to benefit.

In summary, dividend waivers can be successful provided they are not used excessively or repetitively and provided they are commercially justifiable. It is important to follow the legal and company secretarial requirements such as formal deeds of waiver. It is also important that interim dividends are waived before payment and final dividends are waived before the shareholders approve them at the AGM.

In addition, it is always good practice to ensure dividends paid to a spouse are paid into the spouse’s bank account rather than the couple’s joint account.

What about the use of Alphabet shares?

Alphabet shares are often used to provide flexibility on voting dividends and in order to avoid the problems which can arise on dividend waivers.

These can work fairly well, but HMRC can still seek to apply the settlement rules where the level of dividend paid on a particular class of shares is ‘excessive’ when considering the company’s reserves and the level of dividends paid to other classes of shareholder. In addition, excessive use of alphabet shares by a company is likely to attract the initial attentions of HMRC, even where no tax avoidance motive is at play.

In summary therefore, alphabet shares can be very useful, but can create problems when used to extremes.

For more information on tax planning strategies please contact Lesley Stalker at las@rjp.co.uk.