Taxman loses tribunal case

PETER HARRUP of PKF says a family-owned company can still offer tax-efficient remuneration

Despite the fact that this involves two layers of taxation (one on the profits of the company and then another when those profits are extracted by the owners, principally by way of dividend) this can often be more tax efficient than incurring up to 50% Income Tax, plus National Insurance contributions, on the profits of an unincorporated business as they arise.

The dividends can be taken as and when the owner needs the funds, which also means that Income Tax liabilities can be streamed, rather than all arising in the period in which the profits are earned.

Where the main person working in the company is married or in a civil partnership, it is also common practice to issue shares to both partners, thereby utilising the personal allowance and basic rate band of the non-working partner to ensure that the dividends he or she receives are taxed at a lower rate.

HM Revenue & Customs has challenged this type of arrangement in the past under the tax settlement rules. However, the House of Lords’ decision in Jones v Garnett in 2007 demonstrated that a “get-out clause” in these provisions applies to the issue of ordinary shares to spouses and civil partners on the basis that they constitute more than just a right to an income stream.


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HMRC has recently tried to apply these rules again, this time to a Mr & Mrs Patmore. However, the Tax Tribunal ruled against HMRC in the resulting tax case, heard in May this year, on the basis that the arrangements between husband and wife did not constitute a settlement.

For a settlement to exist there must be an element of “bounty”. In other words, someone must have transferred value to someone else “in consideration of natural love and affection” or, in other words, the transfer is in excess of what would be expected between third parties operating at arm’s length.

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In this case, Mr and Mrs Patmore acquired the company from another family as joint purchasers. They were jointly and severally liable for the consideration outstanding, and for repayment of the mortgage taken out to finance the upfront purchase payment. As such, it was held that it was only right and proper that Mrs Patmore was entitled to half of the share capital acquired and therefore half of the dividends arising.

Given that the previous Labour Government’s proposed “income shifting” rules did not see the light of day, and the present coalition Government seems to be more interested in replacing the current IR35 legislation, it seems that for the foreseeable future, at least, there will continue to be opportunities for couples to split business income between them in a tax-efficient manner, provided the settlement rules do not apply.

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