Chat with us, powered by LiveChat

Understanding the taxation of small company dividends

How can they help reduce your tax?

What are the benefits of dividend use for husband & wife companies?

Last year the taxman started taking exception to this and has printed guidance affirming that in many partner companies the legislation on settlements might apply.

So, what exactly do you want to hear?

The verdict that most owners are eagerly wanting, is finally here. But are we any nearer to having clarity on this subject regarding dividend use for Husband & Wife companies? Of course, we aren’t!

Are there any benefits?

A traditional benefit of starting a smaller firm is the chance for you and your significant other to be shareholders to extract monies by producing dividends to you both; And because standard-rate taxpayers don’t get taxed on their dividends, this has predominantly fallen to the spouse who hardly makes any salary.

However,

The guidance they issued was not clear, and there was a question as to its legal sounding.

This first case, is what lots of tax professionals plus small business Directors have been holding their breath waiting for.

So…here are the details of the case of ‘Arctic Systems’

The fresh case of Arctic Systems versus Revenue was of a couple that own an IT firm in West Sussex named Arctic Systems. Their names being Geoff & Diana Jones.

They were both shareholders, although Geoff was the solitary Director. Both took profits through dividends which means they managed to achieve huge tax savings, which is the case with numerous family companies.

Revenue issued guidance regarding the legislation on settlements the year before, and all was well and good up to that point. It would mean the entire dividends would need to be given to the main partner (Geoff). The other partner’s personal allowance plus standard tax band wouldn’t be available, which would undoubtable result in an enlarged tax bill.

Identify key tax planning opportunities with our

Complete guide to dividends tax planning

Only £7.00....normally £27.99

You’re probably thinking, does this apply to me?

We can see if this all applies to you and your company by looking at the underlining facts of Artic Systems in more depth.

Artic Systems Ltd is owned & managed by Geoff & Diana, and Geoff does the technical duties, while Diana acts as the company secretary and takes care of all the financial and administrative needs. These obligations take three to six hours a week to complete.

The company's capital shares are owned 50/50 by Geoff & Diana, each having one share, and Geoff being the sole Director. Diana initially subscribed £1 for her one share. It paid minor salaries to both, and they had declared substantially bigger dividends.

The Revenue uses the legislation on settlements to contest the income that is given to Diana who is the non-working partner.

Let me explain what a ‘settlement’ is…

A ‘Settlement’

The provisions regarding settlement say that when a settlement is made by a person, all income made from asset must be taxed, and must be in the hands the person who the settlement is made from, if the income can be paid to either him, or his spouse.

Click to Tweet

For legislation to take effect, a 'bounty' must be seen - something handed to the spouse in return for nothing.

A special exception which discounts the gift from one partner to the next partner spouse, except if the property given is 'wholly or substantially a right to income'.

But…

Until 12 months ago, Revenue didn’t consider this as being applicable to spouse firms and has consistently been presumed that any shares given as a gift in a smaller firm isn’t 'right to income’, but it is a lot more.

Although, guidance issued by Revenue explaining their views on when it would consider settlement. Continuously this has been a prickly issue and countless tax pro’s still thought that this was not correct. They have consequently been patiently waiting on this verdict with much eagerness.

Let me tell you about the View of the First Commissioner

The commissioner explained that the shares use, the small wages and much higher dividends deemed an 'arrangement' and the dividend the spouse received was deemed to have come from settlement.

Commissioner had governed that the exemption for spouses cannot apply because Geoff is the single director.

And what about ….the View of Second Commissioner

The other commissioner had a different opinion. She specified that an acquisition of one share might be deemed a settlement, but that didn’t apply here. She felt the share to Diana was not a right to income.

Nobody could say at the start whether it might become an income in the future, and regular shares actually mean the holder has host of rights that far surpass a right to an income.

The ruling commissioner casted her major vote, which meant the Revenue viewed this to be a win.

Did this mean that it was likely to be appealed?

Their lawyers would like to, so we will certainly be hearing more about this case. They originally approached the Revenue to pay for the appeal. Revenue have agreed to things like this in previous cases where the cases that would have a huge impact towards taxpayers.

Revenue had incredibly declined in this instance as they did not see a huge impact happening.

A 'fund' was created as a fund-raising exercise in attempts for this to be taken to the next step.

​Join The "how to reduce your tax" club

Here's what you will get:

  • chevron-circle-right
    ​Exclusive Articles
  • chevron-circle-right
    ​Latest Tax Planning that Works
  • chevron-circle-right
    ​Tax Saving Tips and Ideas

​Enter your Email here to Sign Up Today!!

But where does this leave you?

There are numerous pro’s that believe the verdict is incorrect on both technical, and procedural grounds.

The vast majority say this was wrong and that one commissioner should not technically gain 2 votes. If the first commissioner might always out-vote the other, then there is an argument as to whether there is any need in being two commissioners at all.

Considering the vast protests, I'd be astonished if it is the end of it, even after the Revenue have announced they will deliver comprehensive guidance in the light of this verdict.

The presiding commissioner has used the fact there was just one director as a specific argument to make the provisions of settlements into the forefront.

It was claimed that there wasn’t an absolute gift from Husband to Wife, as she was only eligible for dividend income that can be given if Mr Smith, as solitary director, wanted to distribute profits.

Merely electing an extra director wouldn’t, by itself, be expected to evade the provisions, and therefore it is imperative not to place too much emphasis on the point in the previous paragraph.

So, to sum up…

So, until it could be overruled by a conflicting court verdict or additional guidance, we are in limbo and must rely on the earlier guidance from Revenue being valid, but is this really acceptable?

Sarah Aubert