Can I Reduce Limited Company Tax with My Spouse?
Company owners can make big tax savings by transferring shares to their spouse or civil partner. The good news? There’s no Capital Gains Tax on gifts between married couples – however, careful planning is required for the diversion of income to be tax-effective. If you are a cohabiting couple, and not married or civil partnered, please be aware that your tax position is very different. Read on to discover how you can save tax through using Alphabet Share structures, while abiding by the rules of the Settlements Legislation.
We recommend seeking professional advice before any transfers take place – get in touch with one of our tax advisors to discuss your circumstances today.
Put Your Spouse on the Payroll
First, if your spouse is working in the company, depending on their circumstances, it could be important to get them on the payroll.
If you’re both on the payroll, you can utilise your tax-free allowances by paying yourselves salaries up to the Primary Threshold, resulting in no PAYE or NICs, while maintaining your entitlements to state benefits and state pensions. You’ll also get Corporation Tax relief on your salaries, and can top up your income with dividends. Note that if you do pay secondary Employer NICs, you could be eligible for the £5k Employment Allowance to offset them.
There are benefits twofold to putting both of you on the payroll; 1) you will get further tax relief, and 2) you will reinforce to HMRC that you are both bona fide employees with interest in the company.
What are Alphabet Shares?
The term “Alphabet Shares” is used to describe different classes of ordinary shares in a company – usually labelled A shares, B shares, C shares, etc, which can all give entitlement to dividends.
Each type of share can offer different voting rights and/or restrictions (whether redeemable or non-redeemable), and when dividends are paid, shareholders receive payment in proportion to their shareholdings. For example, the shareholder with A shares may be paid at a different rate, to those with the B or C shares. You can even base your dividends on individual or company performance targets.
Alphabet Shares for Spouses
Alphabet shares can be used for giving different amounts of dividends to different shareholders, or limited voting rights at meetings, but what’s their main benefit? Ultimately, you have the flexibility to pay different dividends to each shareholder, without having to change the shareholdings. This is where significant tax savings for married couples or civil partners can take place.
For example, your spouse starts working as an officer of your company as a director or company secretary (legitimately), becomes a shareholder, and gets paid salary (see above) and dividends. You may be a higher or additional rate taxpayer, and receive less dividend as a result, and instead utilise your spouse’s tax allowance (who may be a basic rate taxpayer or pay no tax at all). The result? A lower tax bill for the pair of you – if the shares are structured correctly.
The Settlements Legislation
What is a Settlement, you might ask? It includes “any disposition, trust, covenant, agreement, arrangement or transfer of assets” – ultimately, where a spouse (the settlor) retains an interest in property or income settled to the other lower-tax paying spouse, for the purpose of tax advantages.
This is where the Settlements Legislation comes into play. If you don’t follow the anti-avoidance rules, HMRC may argue that the dividends are a “Settlement” and remain taxable on the donor spouse (as opposed to the other spouse), counter-acting the original reasons for the share transfer.
You should also make sure that your company has sufficient distributable profits, that are capable of being paid on all share classes. Otherwise, this may fall within the Settlements Legislation as a “bounteous arrangement”.
Outright Gifts
However, the “outright gift” exemption for spouses sits outside of the Settlements Legislation. This is where one spouse gifts income to the other, which mustn’t be subject to conditions or reclaimable, “must carry a right to the whole of the income” and must not be “wholly or substantially a right to income.”
As long as a spouse or civil partner is given ordinary shares with the full range of rights (e.g., rights to voting, to future capital from winding up of a company, to dividend income, etc.), then any dividends paid to them should be treated as their income. A lack of rights will get caught out by the legislation, as the shares would be classed as a right to income. In short, the only difference should be the right to dividends.
The Arctic Systems Case
Let’s look at one of the most notable tax cases which covers this exemption, the “Arctic Systems” case (Jones v Garnett (HMRC) 2007). In this case, Mr Jones earned all the profits, yet his wife was an equal shareholder, so the House of Lords concluded that Mr Jones had created a Settlement for his wife’s interest.
But, Mr Jones argued that although the transfer represented a Settlement, it was one ordinary share, and thus an “outright gift,” which meant the Settlement rules didn’t apply. The Lords ruled in his favour; the Settlement was at a no gain/no loss value between spouses, it didn’t represent “wholly [a] right to income,” and it came with other share rights.
The result? Mr Jones won the case, and Mrs Jones’ dividends were permitted as her income only. If Mr and Mrs Jones hadn’t been married, or their shares were split without the same rights, HMRC would have likely succeeded in their claim.
Alphabet Shares and Capital Gains Tax
Alphabet share transfers between spouse or civil partner shareholders are usually covered by TCGA 1992, s 58(1), which allows one spouse to gift shares to the other at a no gain/no loss value, if they are living together. The spouse acquiring the shares receives them at the original cost to the transferor on the date of transfer.
However, for Capital Gains Tax purposes, if the business may be sold in the future, a share of at least 5% must be owned by both of you, in order for each to claim Business Asset Disposal Relief.
Dividend Waivers vs Alphabet Shares
Another option for one shareholder to be paid at a different rate, is a dividend waiver – where one of the shareholders holding the same type of share waives their right to all or part of the dividend.
Still, HMRC are highly suspicious of dividend waivers, especially if there aren’t sufficient distributable profits to pay the full dividend, without the waiver in place. These types of ploys are frequently challenged if HMRC deems that they haven’t been made with genuine commercial benefit in mind. Plus, shareholders must give their consent to dividend waivers every time, which can be unreliable. Alphabet shares on the other hand do not require such consent, making them a more permanent solution to distributing dividends disproportionately.
An exception can be made if one spouse starts to receive a variable second income, which no longer makes a 50:50 income split tax efficient. However, if you do choose to waive dividends, there have to be legal documents that are signed and witnessed, and, the waiver must be in place before the dividend is paid. Waivers should be used for a one-off situation rather than on an ongoing basis.
Structuring Alphabet Shares between Spouses
To decide how much dividend to pay their spouse on an annual basis, many company owners issue themselves A shares, and their spouse B shares. Before doing so, keep the following in mind:
Make the shares Outright Gifts
As stated above, the new alphabet shares must be an Outright Gift, with the same rights as the original ordinary shares. There must be no voting restrictions, no lesser rights to capital, and no promise to return the shares. They mustn’t be redeemable or preference shares.
Don’t create them just before dividends
Try to time the share transfer or allotment carefully. Shares created before a dividend is due, or when the company has large income reserves, may persuade HMRC to view this as the sole reason for share creation.
Make your spouse a company officer
When a spouse gifts shares to the other, you need to show that they have a genuine interest in running the company. You could make them a company director, or at least a formal role in the company as company secretary.
Pay dividends into the receiving spouse’s account
HMRC pays close attention to where company dividends are paid – so make sure they’re going into an account with the receiving spouse’s name (a joint account is sufficient).
Pay some dividend to each share type
To avoid HMRC claims that dividends couldn’t have been paid unless one share class was allocated no dividend, make sure you pay at least some level of dividend to each share type.
Create a shareholder agreement
Even when gifting shares to a spouse, a shareholder agreement protects you if anything changes in the future. Ensure that the agreement states that the company can buy back the shares, and that they’re automatically returned if your spouse dies. This prevents any unwanted scenarios in the future, e.g., the wrong people getting hold of the shares.
Share Reclassification, Amended Articles and Forms
Sometimes, the company already has enough shares, and you don’t need to issue new shares. You can instead alter the existing shares to match your requirements. There’s lots to think about when reclassifying shares, so make sure you’re aware of the following. For example, articles may need amending by special resolution to specify different share rights (and for companies formed pre: October 2009, that are restricted by authorised share capital, there’s a chance to abolish this, or adopt newer model articles):
Amend model articles
This should be carried out by special resolution at a general meeting, thus enabling different share classes to rank pari passu in all respects, aside from the receipt of different dividends.
File a Special Resolution
The special resolution should be filed within 15 days, and due to the model article amendments, will need submitting to Companies House, along with the new Articles of Association (company rulebook).
File a separate resolution
In order to recategorise existing ordinary shares into A and B shares, or create further shares as necessary, you must file a separate special resolution.
File Form SH010
Then, you must file a “Return of allotment of shares” (or Form SH010) with Companies House.
Consider amending the shareholder agreement
If there’s a shareholder agreement in place, think about adjusting any restrictions on new share classes, any pre-emption rights, or requirement to consent (as set out in the Companies Act 2006), to alter the share capital. All shareholders must agree to the amendments, and make sure to check that the Agreement clauses don’t conflict with revised articles – though it isn’t necessary to file the Agreement with Companies House.
Submit Form AP01 or AP03
If the spouse receiving the shares isn’t a director or secretary already, make a decision on their position and submit the relevant form to Companies House – an AP01 for a new director, or an AP03 for a company secretary.
Persons of significant control
Whenever the shareholdings in a company are changed, you must consider whether the existing PSC statements require amendment, or whether new statements are required. These are forms PSC01, PSC04, and PSC07.
Consider HMRC Tax Fee Protection Insurance
In case HMRC does question your arrangements and would like to carry out a tax investigation, we recommend taking out full tax fee protection insurance.
Need Help Saving Tax in Your Limited Company?
Giving shares to your spouse must be done correctly to receive the anticipated benefits. We offer professional tax planning advice in line with the law and best practice – get in touch through our online form, call 01743 562430, or email hello@mercianaccountants.co.uk today.
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