Dividend waivers ruled as settlements cost two directors £27,000

Two limited company directors face a tax bill of £27,000 after a tribunal rejected their claim that shifting income to the wives via dividend waivers was just “tax planning sense,” and not caught by the Settlements legislation, known as 'S660.'

The two men hoped the tribunal would uphold their appeal, which claimed that the taxman’s decision that they owed tax (under S625 of ITTOIA 2005) from shifting their income to their basic rate taxpayer-wives was, “plain wrong in law.”

The two directors, Mr Donovan and Mr McLaren, majority shareholders in the firm, said they used the waiver as they did not want the dividends themselves, and not because they wanted inflated dividends for their wives.

Although the two women were each allotted a shareholding of just 10% but received a disproportionate share of the income (24.6%), their husbands claimed the waivers they signed to that end did not have a tax avoidance motive.

Rather, their decision to waive their entitlement to dividends represented a “commercial decision” to ensure that the company maintained workable reserves and cash balances, which were to be used to fund the purchase of its premises.

The directors’ legal representative, Mr Arthur, argued that the allotment of the shares to the wives represented an outright “gift” that would fall within an exception to the provisions, although this defence only surfaced at the hearing.

Unfortunately for the appellants, the tribunal agreed with the Revenue’s stance that a dividend waiver is not a “gift,” and upheld the tax authority’s other interpretations, including those relating to “an arrangement,” “bounty” and “retained interest.”

Its ruling adds that it was unconvinced by the directors’ claim that there was a commercial reason for the waivers, and says the intention was to exploit the wives’ lower rate of income tax to make an overall tax saving.

Reflecting on the judgement, advisors at Assured Tax Consulting characterised the outcome in favour of HM Revenue & Customs, which demanded tax from the directors for the three years ending 5th April 2010, as “predictable”.

This lack of surprise owes to what the directors did closely resembling the aim of the settlements provisions -- to stop an individual from gaining a tax advantage by making arrangements that divert their income to another who is liable to tax at a lower rate

The advisors added: “HMRC are paying close attention to income splitting and this is the fifth consecutive case HMRC have successfully argued since Arctic Systems.

“It is essential to ensure any income splitting arrangements are structured carefully to ensure everyone remains protected. Needless to say there is little point in structuring your income in a way which ultimately leaves you exposed to a personal liability.”

The Practical Law Company (PLC), whose analysis of the ruling is available online, seems to agree, in that it says Donovan & McLaren V HMRC represents “a classic case of income-shifting to take advantage of a spouse’s lower marginal rate of tax.”

But in light of other rulings (under the provisions) handed down since the Arctic Systems case, the PLC also cautioned: “Dividend waivers to shift income can no longer be seen as ‘tax planning sense’, which is how the appellants' representative before the tribunal described the arrangement.

“Owner-managed businesses will need to look at any arrangements for shifting income to see if they fall within the exception that was found to apply in Jones v Garnett (in which case, they should be safe from counteraction). Otherwise, the arrangements may need to be revised.”

Editor's Note: Further Reading -

Tax review chief eyes husband and wife companies

Osborne 'unlikely to hit husband and wife firms'

Taxman still chasing husband and wife firms

Feb 13, 2014