Business owners often seek to minimise the tax position of shareholder-directors by involving members of the same family and using personal reliefs and lower rate tax bands of each person.
But is this still an advisable strategy in the current anti-avoidance environment? Yvonne Jackson, partner and chartered accountant at Clayton & Brewill offers advice for business owners.
Owner managed companies often seek to divert income from higher rate tax payers by spreading income around members of the same family and using the personal reliefs and lower rate tax bands of each person.
It is important however to consider anti-avoidance rules before deciding on such a strategy.
Arrangements between spouses
Where it is considered that arrangements have been made by one spouse which contain a gift element, often referred to as ‘an element of bounty’, then the ‘settlements’ rules may apply. A key purpose of these rules is to ensure that income alone, or a right to income, is not diverted from one spouse to the other.
Genuine outright gifts of capital or a capital asset from which income then wholly belongs to the other spouse are not caught by the settlement rules because of a specific exemption.
Family company shares and the dividend income they generate have frequently been the subject of HMRC challenges. An example of a structure which will be challenged is the issue of a separate class of shares with very restricted rights to a spouse, with the other spouse owning the voting ordinary shares.
Be careful when using dividend waivers
An area of potential risk is the recurrent use of dividend waivers, particularly where the level of profits is insufficient to pay a dividend to one spouse without the other waiving dividends.
In a recent tax tribunal case, dividend waivers executed by two husbands in favour of their spouses were found to constitute a settlement for income tax purposes. The dividends therefore became taxable on the husbands’ income.
The basic facts were that two directors of a company each owned 40% of the shares in the company. Their wives each owned 10% of the shares. Dividends totalling £130,000 were paid in respect of the shares in the company’s accounting period to 31 March 2010, split as follow:
- Mr D £33,000 (25.38%)
- Mrs D £32,000 (24.62%)
- Mr M £33,000 (25.38%) and
- Mrs M £32,000 (24.62%).
This clearly does not correspond to the legal and beneficial shareholdings and had been achieved through dividend waivers. The directors had used the same type of mechanism to allocate dividends for the previous ten years.
HMRC argued that the taxpayers had waived entitlement to dividends as part of a plan to avoid tax. The directors argued that they had used the dividend waivers to help maintain the company’s reserves and cash balances in order to fund the purchase of the company’s own freehold property.
‘An element of bounty’
The Tribunal preferred HMRC’s arguments and determined that the waivers would not have been made if the other shareholders were a third party (ie: not family members) and that therefore there was ‘an element of bounty’ sufficient to create a settlement.
Sensible tax planning is a valuable way of mitigating your tax liabilities but care has to be taken in the current anti avoidance environment to avoid the traps.
For considered but effective tax advice for business owners contact Clayton & Brewill on 0115 950 3044 or click here to send us an email.
Clayton & Brewill is a firm of chartered accountants with offices in Nottingham, Melton Mowbray and Long Eaton.