The government has promised to crack down on ‘income
shifting’. This is where someone can reduce their tax
liability on business earnings by paying dividends or partnership
profits to a non-working spouse or civil partner. Details
of the proposed new rules were announced on 6 December 2007.
The announcement leaves a window of opportunity to save
tax by paying dividends before 6 April 2008, because the
new rules will not take effect until the tax year 2008/09.
HM Revenue & Customs (HMRC) had challenged income shifting
under existing anti-avoidance legislation in the Arctic Systems
tax case. But in this case, the House of Lords rejected the
attempt to tax the husband on dividends paid to his wife,
even though the husband’s work generated most of the
company’s income.
Since the Lords’ ruling in the summer,
HMRC has issued guidance which confirms that
where a non-working spouse holds ordinary
shares with rights to the company’s capital, dividends
can only be taxed as the income of the spouse
to whom they are paid.
You can therefore save tax by paying a dividend
before 6 April 2008 up to the limit of a non-working spouse’s basic
rate income tax threshold. Remember though
that you have to count as income the 10% tax credit as well as the cash
dividend itself. You can even give your spouse
shares shortly before paying the dividend,
provided you make an unconditional gift
of ordinary shares with full voting rights.
But there are some restrictions. The
company must have enough accumulated income
out of which to pay the dividend to all shareholders,
or to all holders of shares of the same
class. (Most family companies have only one
class of share.) HMRC is likely to succeed
in a challenge under the present rules where
the working spouse, who holds shares, foregoes a dividend
so that a larger dividend can be paid to a non-working spouse.
This could be your last chance to save tax in
this way. We can advise you on making the
best use of current rules and on whether you
should change the way your business is
set up for the future. The new rules for income
shifting, together with changes to tax
rates for individuals and companies, start in April 2008.
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