12. S660 'income splitting' and Managed Service Company legislation – What's it all about?
S660 rules (also known as "settlements legislation") aims to stop limited company owners from passing income to another shareholder, eg a member of the family, who pays a lower rate of tax.
This is called a "settlement", i.e. settling their income on another person who will benefit by paying less tax on that income. Where the legislation applies, HMRC seek "tax, interest and penalties".
Family, or 'husband and wife' companies have used this method of tax planning for many years, perhaps one as the main fee earner and the other carrying out administrative tasks. Both shareholders may receive profits by way of dividend.
A high profile case (Arctic Systems Ltd) regarding the taxation of family businesses has been under the spotlight in recent years. The Revenue's argument in this scenario was that if the wife's income stems mostly from the husband's work, then he has given her a right to his income i.e. the dividends that she gets on her shares in the Company, and therefore this should fall under S660 as a settlement.
HMRC guidance outlines one example where a case may be taken up as "Main earner drawing a low salary leading to enhanced profits from which dividends can be paid to shareholders who are friends or family members."
It also states that each case is different and with that they look at the 'whole arrangement'. Therefore the work carried out by both parties, i.e. the contribution to the company, and whether the salaries drawn (or "commercial reward") are at commercial or market rates. HMRC guidance states: "If the facts show that the business is a commercially run joint venture and the income flows reflect that, it is unlikely that any income will have arisen under a settlement."
There is more on the history of the legislation and analysis of the Arctic Systems case in our S660 section.
Alongside being in business on your own account, either as a sole trader or using a limited company, or using an umbrella company, there were, until recently, popular alternative schemes in the form of managed service companies or composite companies. This form of company structure placed contractors into groups of shareholders in a corporation owned and run by the service provider, providing contractors with the tax benefits of working through a limited company without the overall responsibility.
HMRC introduced legislation in April 2007 to ensure that any income received by workers operating through an MSC would be subject to employed levels of tax and NICs, thereby removing the tax advantage of such schemes.