Transfer Part of Your Business
and Enjoy Huge Tax Savings
Save Tax with Business Transfers
MANY COMPANY owners are able to make huge tax savings by passing part of their business to their spouse or partner.
For Better or Worse
Before embarking on this type of planning, it is essential to understand that it will only be effective if part of the beneficial ownership of the business is genuinely passed to your spouse or partner. They must have genuine rights to part of the income and part of any proceeds on an ultimate sale. They must be entitled to do as they wish with their share of the income or sale proceeds and there must be no prior arrangements to pass the resulting funds back to you.
If you are not completely happy with following these rules, then this type of planning is simply not for you.
Passing Shares Across
For a married couple or civil partnership, it is relatively easy to pass shares in an existing company to a spouse or partner, as the transfer is exempt from Capital Gains Tax (CGT).
For unmarried couples, the position is less straightforward, as a transfer of shares in an existing company will generally be treated as if the transferor had sold the shares at market value for CGT purposes. In many cases, however, the couple can jointly elect to claim holdover relief so that the shares can effectively be treated as if they had been transferred for a price equal to the original purchase cost. Hence, the transfer can be made without giving rise to any CGT liability.
Note that ‘holdover relief’ is generally only available where the company is carrying on a qualifying business – usually a trade or furnished holiday letting. For other types of company, the problem of CGT liabilities on a share transfer to an unmarried partner will remain, but can often be side-stepped by transferring the shares via a trust.
Until recently, many people used preference shares or ‘ABC’ companies as a means to pay dividends to spouses or partners without giving them the same rights as an ordinary shareholder. In principle, these types of arrangements can still work, although it is usually necessary for the spouse or partner to also have a significant right to part of the capital value of the company. Nonetheless, these arrangements have been the subject of several attacks by HMRC in recent years and it is therefore generally safer to simply pass normal ordinary shares to the spouse or partner.
Once you have managed to get some shares into the hands of your spouse or partner, they will be entitled to part of any dividend paid on that class of shares. This provides scope to utilise any part of their basic rate Income Tax band not already used up by other sources of income. Dividends received by a basic rate taxpayer are effectively tax-free.
In this way, it is possible to pass tax-free dividends of up to £38,227 (at 2011/12 rates) to your spouse or partner, generating savings of up to £13,800 each year!
Harry has a successful trading company, generating profits of over £300,000 each year. Until recently, he has been paying himself an annual dividend of £152,000 in addition to his salary of £50,000. If he continued to pay himself this level of dividend in 2011/12, it would give rise to an Income Tax liability of £44,889, calculated as follows:
Dividend received £152,000
Add: tax credit (one ninth) £16,889
Income Tax due
£100,000 at 32.5% £32,500
£68,889 at 42.5% £29,278
Less: tax credit (£16,889)
Instead, however, Harry transfers 25% of the ordinary shares in his company to his wife Pippa. The company then pays the usual dividend of £152,000 but, this time, only £114,000 is paid to Harry and Pippa receives £38,000. Pippa has no other sources of income, so her dividend is completely tax-free. Meanwhile, Harry’s liability is calculated as follows:
Dividend received £114,000
Add: tax credit (one ninth) £12,667
Income Tax due
£100,000 at 32.5% £32,500
£26,667 at 42.5% £11,333
Less: tax credit (£12,667)
The couple’s total income before tax has remained the same but, by transferring part of the shareholding to Pippa, they have been able to save £13,723.
This method can be further refined by alsopaying Pippa a small salary, if justified by the work she does for the company.The most beneficial level of salary would either be £7,225 (the primary National Insurance threshold), or £7,475 (the personal allowance), depending on the company’s profit level.
In Harry and Pippa’s case, a salary of £7,475 paid to Pippa would increase the total annual saving to £14,084 (taking account of all taxes, including Corporation Tax and National Insurance).
For a typical higher rate taxpayer, with personal income of less than £150,000, the potential total tax saving by making their spouse or partner a shareholder and paying them a salary of £7,475, together with dividends of £31,500, is up to £9,861 each year (at 2011/12 rates).
Income Shifting Problems
The technique described above has been used successfully by many couples for many years. In the infamous ‘Arctic Systems’ case, however, HMRC extended its attack on these ‘husband and wife’ companies to cases involving normal ordinary shares. Thankfully, HMRC eventually lost that case and this technique therefore currently remains effective for married couples and civil partners.
There is perhaps some doubt as to whether this tax-saving strategy is beyond HMRC’s reach in the case of unmarried couples, although there does not seem to be any sign of a concerted attack at present.
For all couples, married and unmarried alike, there is also the threat of future changes to tax legislation which may diminish or eliminate the savings generated by this well-known tax planning strategy in some cases. (The taxation of small businesses is currently under review.)
The best defence against any attack from HMRC or change in legislation is probably to ensure that both members of the couple are actively involved in the business. Being ‘actively involved’ means more than book-keeping and administration: the taxpayer’s wife in the Arctic Systems case was carrying on these duties but HMRC still chose to attack the couple!
Other tax legislation focuses on individuals working less than ten hours per week in a business, so it is quite possible that this is the benchmark which couples should aim for in the future.
Capital Gains Tax Benefits
Most owners of unquoted trading companies are now able to sell their shares and pay CGT at just 10% by claiming Entrepreneurs’ Relief. The lifetime limit for total capital gains subject to Entrepreneurs’ Relief was increased to £10m from 6th April 2011.
When transferring shares to a spouse or partner it is vital to ensure that the transferred shares will continue to qualify for Entrepreneurs’ Relief on the ultimate sale of the company. Get this right and up to twice as much capital gain could benefit from the relief; get it wrong and the relief will be lost on the transferred shares. You might call it a case of ‘double or quits’.
The qualifying criteria for shares in a private company for the purposes of Entrepreneurs’ Relief are as follows:
- The company must be carrying on a qualifying business (generally a trade or furnished holiday letting).
- The individual must be an officer or employee (many small company owners appoint their spouse or partner as company secretary).
- The individual must own at least 5% of the ordinary shares and voting rights.
All of these conditions must be satisfied for at least a year prior to the sale of the shares.If the transferee does not already meet one of the above criteria, it will be necessary to wait at least a year before selling the company in order to qualify for Entrepreneurs’ Relief. Alternatively, it may be preferable to transfer most of them back to their original owner in order to secure the benefit of the 10% rate (where the total gains do not exceed £10m).