A tax efficient means of remuneration for many small business owners is by way of dividend rather than salary. This itself is not under threat, but in certain instances where non-working spouses receive dividend payments the Inland Revenue is beginning to take an aggressive new stance. Their avenue of attack is the so-called Settlements legislation which can apply to transfers of assets or “arrangements” generally.

Under this legislation, the income arising from a Settlement can be taxed on the “Settlor” if his/her spouse is the beneficiary of the arrangement. A typical example is a husband giving his wife some shares in his company so that she can receive dividend income from them. The position would be more extreme if arrangements (perhaps dividend waivers) were implemented so that higher than normal dividends were paid to the wife. The Inland Revenue’s argument under the legislation seems to be that, irrespective of who received them, the dividends should be taxed on the “Settlor” in respect of the arrangements – usually the working spouse.

The good news, however, is that the legal validity of the Inland Revenue’s position is far from certain. Furthermore the Courts have ruled that for the Settlements legislation to apply the arrangement must involve an element of bounty, i.e. the legislation cannot apply if the recipient pays a fair price for the assets.

Defensive measures

Various steps can be taken to make any arrangements less vulnerable to attack. The best is to ensure that there is no Settlement in the first place. If dividends are only paid to the working spouse and that spouse acquired the shares in an arm’s length transaction, there could be no Settlement.

If that spouse chose nominally to own the shares jointly with the other spouse whilst retaining the whole of the beneficial interest in the shares, there would still be no Settlement. However, unless the spouses elected otherwise, the charging legislation would oblige the Inland Revenue to tax half of any dividend paid on the jointly owned shares on each spouse.

Alternatively, as stated previously, the recipient spouse could pay a market price for the shares. Care is needed here because a subsequent arrangement under which large dividends were targeted at the non-working spouse could be seen by the Inland Revenue as a Settlement.

Such an attack would be less likely to succeed if the working spouse was paid an arm’s length rate of remuneration by the company and dividends were paid at the same rate on the shares of both spouses.

Barnes Roffe Topical Tips

• Dividends which are paid to non-working spouse shareholders in family companies should be reviewed in the light of the Inland Revenue’s apparent new, aggressive position.
• Ensure that there is no element of bounty inherent in any arrangements that exist.
• Joint shareholding arrangements where there is no transfer of the underlying beneficial interest are probably the safest course of action as there is no Settlement and the Inland Revenue must tax the income on a 50:50 basis.