The HMRC monitor businesses owned by spouses closely, in an effort to stop business partnership where one spouse is considerably less active and exists as a partner as a means to divert income and save tax.
The settlements legislation is the regulatory document that acts as a way to limit against tax avoidance. Contractors trading in a limited company that want to share company ownership and income with a non-fee-earning partner, family member or friend is at risk of inspection from the HMRC, which can lead to penalties.
Following a the House of Lords ruling against the HMRC in the Artic Systems case, the HMRC cannot apply settlements legislation to arrangements between spouses. As long as the shares involved are ordinary class shares a fee-earning contractor can jointly own a limited company with their non-fee-earning spouse or civil partner, and split the income from ordinary shares.
However, the Arctic System case did not provide an exemption for contractors seeking to split share ownership and income with a non-spouse, i.e. partner, family member or friend. In order to limit against the HMRC claiming foul play and enforcing penalties on shares an income that has been ‘settled’, the income must be justified on commercial grounds.
A non-earning spouse can make an investment and buy shares in the contracting business at a market rate. This can be a good option for businesses that expect to grow beyond a single fee-earning contractor. However, there is a risk of limited to no financial net benefit for the non-fee owner.
Justifying the share split and income
A non-fee earner is not non-working. Many companies rely heavily on non-fee earners to do vital jobs like send out invoices and handle banking. Therefore, if the non-fee earner has a definite role in company it is possible that the HMRC will view a split shares and income as justified.
Contractors must be aware of a number of factors that could flag their income/share split as tax avoidance.
· Complex share structures with multiple classes of shares. The HMRC will question any shares that are not ordinary.
· Using dividend wavers to shift the fee-earner dividend payment to a spouse.
· Failing to complete and file paperwork. All shared and dividends must be supported by paperwork. If they are not, the HMRC can reclassify the payments as earning, not dividends, resulting in more taxes and penalties to pay.