Contractors' Questions: Can I 'income-split'?

Contractor's Question: I own a limited company and am considering 'income-splitting' with my wife who no longer works. She does some work for the company - secretarial stuff mainly, but nothing that I would invoice clients for or create an auditable paper trail to prove.

Can I make her a shareholder, pay salary and split dividends with her in order to structure our tax affairs more efficiently, resulting in a lower tax burden? I've read about the Artic Systems case and the reports seem to indicate that such action is legitimate but that the government wanted to change the law to make it unlawful. As they have not done so, yet, does that mean I can 'income split' with impunity, or at the least demonstrate 'reasonable care' in doing so? My accountant recommends that I don't income/dividend split, but is such advice too risk adverse?

Expert's Answer: The question you pose is really about whether 'income-splitting' creates a settlement of income from one person to another. This is important as under UK tax law (previously S660A ICTA 1988, now Chapter 5, Part 5 of ITTOIA 2005) the income would be taxed as still belonging to you (i.e. the settlor).

In order to achieve 'income splitting,' shares would be gifted from you to your wife, and it is this action which can create a settlement. The Arctic Systems judgement stated that in the context of the facts of that case, although the gift of ordinary shares was bountiful, it was an outright gift and not a gift solely of income. A gift is not an outright gift where it is subject to conditions or in circumstances where the 'giver' will receive a benefit from the property or income or proceeds from that property.

In short, the answer to your question is that it is possible to pass shares to your wife that give her the right to receive dividends provided that they also give a right to receive capital and that you do not attach conditions to the gift or derive benefits from the shares you have given away. Your accountant has suggested that you do not go ahead with such a gift, but you have not said on what basis he issued this advice. It may be that what you propose does not meet the tests mentioned above.

With regard to the change in legislation on 6 December 2007, the government announced consultation on new legislation which would rule out this practice (the so-called 'income-splitting' regime). This draft legislation was 'postponed indefinitely' in the 2008 pre-Budget report. At present the Arctic Systems ruling remains valid.

The expert was Paul Spindler, a technology partner at Kingston Smith LLP, the chartered accountants. For further advice on the above guidance, contact