Contractors' Questions: Can I take profit from my husband?

Contractor’s Question: My husband and I have set up a limited company. We are the only directors and have equal shares. Although most of the work is being done by him, can the majority of profit from the business be paid out to me as dividends? I am a lower rate taxpayer than my husband so this would reduce our overall tax liability.

Expert’s Answer: This arrangement is common, but in practice it is a minefield. Many businesses are set up as husband and wife companies but the way they are taxed will depend on how they are structured rather than on who does the work. The facts here look very similar to those tested in the Arctic Systems case – Jones V Garnett – a few years ago.

Special rules apply where individuals seek to divert income to members of their family to save tax. By setting up the company and allocating share to the non-working wife, the husband has created a settlement.

If HM Revenue & Customs considers a settlement has been made, the income will be taxed as if it is the husband’s rather than his wife’s money. However in the case of a husband-and-wife business, this rule only applies if the gift is “wholly or substantially a right to income.” HMRC is likely to consider that this is the case where the wife has an equal number of shares in a company and her husband’s endeavours generate most of the income. But it is not clear cut. The shares themselves might have value and so the gift is more than just a right to income.

Remember, too, that dividends are declared on all identical shares, so the husband and wife must each receive an equal dividend. A dividend waiver by the husband would probably be challenged by HMRC.

Professional advice is essential before attempting to divert income in these situations.

The expert was Anita Monteith of the Tax Faculty at the Institute of Chartered Accountants of England and Wales.