Income Splitting and Family Businesses
By David Collier CA CTA
The introduction of independent taxation in 1990 separated the taxation of the income of husbands and wives. This encouraged spouses to consider, where possible, the sharing of income within a family to minimise the overall income tax burden.
The income tax rules allow for the transfer of income producing assets such as listed company shares to be effective for tax purposes provided that the transfer is outright. However until recently it was less clear how the relevant rules applied to planning within family businesses.
Jones v Garnett (also known as Arctic Systems)
The recent House of Lords decision in Jones v Garnett clarified the law in this area. In outline the facts were as follows-
- Mr and Mrs Jones formed a company, each subscribing £1 for one share.
- Mr Jones worked as a freelance IT consultant through the company; Mrs Jones performed some administrative duties.
- Both Mr and Mrs Jones were paid modest salaries by the company.
- The company paid dividends to Mr and Mrs Jones.
HM Revenue and Customs argued that the dividends paid to Mrs Jones fell to be taxed on Mr Jones under part of the tax rules relating to settlements. The House of Lords agreed that there was a settlement. However it was held that the one ordinary share owned by Mrs Jones was not “substantially a right to income” and therefore fell within one of the exceptions to these tax rules. Accordingly HMRC’s attempt to tax Mr Jones on the dividends paid to Mrs Jones failed.
HMRC has confirmed that this decision would be applied to other outstanding cases. Most of these cases also involve the use of companies, but the principles could also be applied to family partnerships.
Future Rules
The House of Lords decision was followed the next day by a government announcement of an intention to change the tax rules in this area. The ministerial announcement on 26 July 2007 said “It is the Government’s view that individuals involved in these arrangements should pay tax on what is, in substance, their own income and that the legislation should clearly provide for this.”
It is therefore likely that the next Finance Act will include changes to the tax rules, but there is no present indication of the date from which these changes will apply, nor to their precise nature.
Website: www.chiene.co.uk
More information on this subject is contained in the guide Salary vs Dividends
