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Business General
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Legislation
Section 660A: The Attack on Husband and Wife Businesses?
A potential new threat to one of the most common means of tax planning is currently on the horizon, as the Inland Revenue is showing increasing interest in situations where husbands and wives are both owners of a business - either as shareholders or partners - but one spouse is considerably less active within the business than the other.
The taxman's weapon is the settlements legislation. In general, this can apply where an individual (the settlor) enters into an arrangement to divert income to someone else and in the process tax is saved. There has to be an element of bounty (ie 'something for nothing').
The legislation is not new, but was originally enacted in the 1930s and brought up to date in the 1990s. Section 660A of the Taxes Act applies to arrangements where the settlor or the settlor's spouse retain an interest in the settlement (such as the right to some of the income). It is this part of the legislation that has been brought into the public eye recently.
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.
Here are some of the situations where the Inland Revenue has said it will consider applying the settlements legislation:
- where the main earner draws a low (non-commercial) salary leading to enhanced profits from which dividends can be paid to shareholders who are friends or family members
- where differing classes of shares enable dividends to be paid only to shareholders paying lower rates of tax
- where dividends are waived so that higher dividends can be paid to shareholders paying lower rates of tax
- where dividends are paid on shares that carry only restricted rights.
The settlements legislation will not apply, however, if the shares have considerable capital value or if the main earner draws a commercial salary before dividends are declared.
The effect of the settlement legislation is that the income of the lower taxpayer is taxed as income of the donor of the gift (the settlor).
The controversy
This is a largely untested application of the legislation, and it throws up a number of anomalies. For example:
- settlements by husbands on wives (and vice versa) are subject to rules which do not apply to settlements with other relatives or friends. It is therefore discriminatory against married couples
- unlike the view taken by divorce courts, the Inland Revenue's stated approach completely ignores the sacrifices that may be made by the 'non-working' spouse in enabling the business to function at all, for instance agreement to personal (matrimonial) assets being pledged as security for the purposes of the family business, as well as looking after the home and children and so on
- the approach contrasts with the freedom to married couples in transferring assets between themselves without any capital gains or inheritance tax liabilities
- although shares transferred to a spouse may be considered to be substantially a right to income in the early days of a company, a successful company may well grow so that eventually the capital value of the shares may greatly outweigh the dividends received.
Prevention
Here are some measures that might protect you from Section 660A:
- 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' spouse 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
- consider holding shares jointly with beneficial ownership entirely for the husband; tax rules deem dividend income to be taxed 50:50 even if it is paid into the husband's bank account!
This area of tax law is currently under much scrutiny. If there are any issues that you wish to discuss, please contact us and we will be glad to help.
Please note: this article is for general information and guidance only. You should always speak to us before taking any action
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