Should you make your husband or wife a shareholder of your limited company?
It’s common practice for a spouse to be added as a shareholder in a limited company particularly where there can be tax efficiencies gained, writes Greg Timson, chief accountant of inniAccounts.
While the process of adding a new shareholder to a company is straightforward, it’s not right for every married couple and there are a number of important areas to consider before transferring shares to a spouse.
Share the dividends
Dividends are issued in line with the shareholdings - if there is only one shareholder, they would receive 100% of any dividends that are paid. If there is a second shareholder who owns half of the shares, then each time a dividend is issued each shareholder would receive 50% of the total dividend.
If an individual is earning over the higher rate tax starting point (£50,270 for the 2022/23 tax year), any dividends falling in the higher rate are taxed at 33.75%. Adding a spouse can make use of their tax-free allowance and basic rate tax band. Dividends in the basic rate are taxed at 8.75% which is a difference of 25%.
As a basic example, if a dividend of £30,000 is issued to a spouse and it’s taxed at the basic rate of 8.75%, the tax would be £2,625. If that dividend was taxed at the higher rate of 33.75%, the tax would be £10,125, which is a difference of £7,500.
Please Note: the above figures are based on 2022/23 tax year rates and thresholds.
For extra tax efficiencies, the tax-free allowance could also be utilised by paying a salary to a spouse if they are helping in the business. Any salary paid should be at ‘market rate’ and reflect the work carried out i.e. what an unconnected individual would be paid to carry out the same role.
It’s worth noting that if the spouse already has income from outside the company which utilises the basic rate tax band, such as employment income, there is unlikely to be much of a tax saving by involving them in the business as a shareholder or employee.
Spousal exemption and Arctic Systems
HMRC has specific legislation in force called Settlements Legislation. This is designed to prevent ‘income-shifting.’ In basic terms, income-shifting is giving personal income to another individual who pays tax at a lower rate.
An example of this is gifting shares to a family member. If the person giving the shares receives a benefit, such as paying less tax, and it’s not an arm’s length transaction then HMRC can look to apply Settlements Legislation and tax the person giving the gift on all dividends received by the family member.
Many years ago, there was the now-famous Arctic Systems case brought under the Settlements Legislation, which involved a husband and wife trading as a limited company of that name. The husband was working as an IT consultant through the limited company, Arctic Systems Ltd, and his wife carried out administrative work in the company.
As 50/50 shareholders, all the dividends were paid out equally between the husband (Geoff Jones) and wife (Diana Jones). However, HMRC argued there was a ‘settlement’ and that the wife’s dividends should be taxed as the husband’s.
Conditions for spousal exemption to apply
HMRC lost the case because although the court agreed there was a settlement, the spousal exemption applied. There are a few conditions that need to be met for the exemption to apply:
- The shares in the company should have full rights for voting, dividends and capital distribution.
- The shares should be an outright gift - any dividends paid out should be the spouse’s to use as they wish and not just a way of rerouting the funds back to the main shareholder.
- The couple must be living together.
Although an exemption can potentially apply in your circumstances, it’s important to be aware of the rules and operate with best practice. An example of this is to ensure that the dividends paid are paid directly to the spouse’s personal bank account.
Dividend waivers and creating different share classes should also be considered carefully -- as it could be argued that these are ‘wholly a right to income’ and maybe more likely to attract HMRC attention.
If the shareholdings are changed frequently, for example if a spouse’s other income changes year-to-year and the shareholdings are changed to help keep dividends within the basic rate tax band, HMRC will take interest. Our accountancy firm’s advice is to decide on the percentages from the start (where possible) and then stick to these to avoid any red flags.
Lastly, other (non-tax) considerations
There are some non-tax related practical points that should be considered before shares are transferred to a spouse.
It’s often not an easy thing to talk about, but one of the main considerations is around what would happen in the case of separation and/or divorce. To make use of the spousal exemption, as mentioned above, the shares should have full rights in terms of voting and capital distributions; they are effectively an outright gift, and you’d need to be comfortable with giving away part of your company.
As with all these not straightforward and not always easy to broach matters, it’s a good idea to get the latest information and guidance from an accountant before deciding, or even planning. Shares can be transferred to a spouse to save tax and they can help with navigating the various tax considerations, but it’s always best to decide – carefully -- based on what’s right for your own personal circumstances.