So you want to make your wife a shareholder?
‘So you want to take money out of your limited company?’ It’s a fair question that advisers to shrewd and well-heeled contractors asked them back in June, in a bid to make the most of their incomes.
But clearly it’s not enough. Feeling the effects of the dividends tax, the potential block on tax relief on T&S expenses and the removal of the NI Employment Allowance for single-director companies, contractors are now asking how their limited company can make their spouse a shareholder, writes Anne Wilson, senior tax manager at Pierce Chartered Accountants.
Before exploring the wisdom of giving away your company’s shares in order to reduce your tax liability and the potential savings, a quick recap for the uninitiated.
In April 2016, changes to the taxation of dividends came into force, resulting in an increase in tax liabilities for almost all PSC contractors. Previously, if you took a salary up to the personal allowance and a gross dividend up to the basic rate band then you would have no tax liability. Since these changes came into play, under the same scenario you would have a tax liability of just over £2,000.
The first thing once you’ve grasped this is for me to bust the myth of giving shares to your minor children. If a parent makes a gift of an asset, including shares, to their minor child then any income in excess of £100 is taxable on the parent while the child is under 18, making the tax saving void.
What about other gifts of shares to spouses, partners or adult children?
In order for a gift to be effective for tax purposes it must be an outright gift, with no strings attached and be more than a gift of income. For example, you cannot create a special class of shares with no rights other than the payment of a dividend as that would be a settlement for tax purposes and the dividend would continue to be taxed on the donor.
The problem with many contractor companies is whether the shares in question actually have any underlying capital value in any event. However, comfort can be taken from the decision in the Arctic Systems case, where a spouse was permitted to subscribe for a share in a company, the income of which derived from the husband’s skills. HM Revenue & Customs argued that the dividends should be taxed on the husband because the wife’s shares were no more than a right to income (the company had no apparent underlying capital value).
Understanding Artic (continued)
However, the House of Lords found that the wife’s share was more than just a right to income; it was an ordinary share conferring the right to vote and to participate in the distribution of assets on a winding-up and to block a special resolution. Following the decision, despite HMRC’s initial intention to change the legislation, this has not happened. So at the present time it is still possible for contractors to transfer shares carrying full rights to their spouse (or partner or adult child) and not fall foul of the Settlements legislation.
Transfers between spouses are exempt from capital gains tax. Where the shares are gifted to partners or adult children the same issues apply regarding the settlement rules, although a capital gains tax hold-over relief claim would be needed to hold-over the gain on the gift of shares. However, a note of caution about gifts of shares to parties other than spouses: once the shares have been transferred they are very difficult to get back in the event of a breakdown in the relationship. I always recommend that a shareholder agreement should be signed in conjunction with the gift. The desire to save tax should never override sound commercial decision-making.
I also recommend that dividend waivers are avoided and if it is intended to pay different levels of dividend, alternative classes of share should be created.
What are the tax savings of a gift?
The answer to this question depends very much on the levels of income received by each party. For example, if the spouse has no other income they would be able to receive a dividend of up to £16,000 free of tax. If the spouse making the gift would have been taxable at the higher rates on the same dividend, then the tax saving would be £5,525! If the donee spouse had other income but would be within the basic rate band then the saving would only be £4,700, in each case it would be important to do the sums as the savings may not always be so generous. But if it is generous tax treatment you’re after, remember that giving some shares to adult children who are at university could be a good way of funding their education, as they can receive £5,000 of dividend tax free!
As you can see, there is still scope to make a transfer of shares to a spouse - or partner such as a boyfriend or girlfriend, to save tax; but the gift must be an outright gift and professional advice should always be taken.