An end to income shifting?
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.