Dividends to spouses
Many one-man companies utilize their directors’ tax-free allowance by paying them a small salary. With proper planning, the director incurs no income tax or National Insurance contributions (NICs), while the company receives corporation tax relief.
Directors can duplicate this process with a non-earning spouse, gaining tax relief on two salaries. For the spouse’s salary to qualify as a company expense, they must take an active role in the business and cannot receive a wage purely for their marital relationship; otherwise, the tax relief could be invalidated.
By transferring company shares, both partners can withdraw excess profits as dividends, enjoying lower tax rates without incurring NICs. Importantly, shareholders are not required to perform company duties to earn dividends.
Playing by the rules
Anti-avoidance rules (ITTOIA 2005, Pt 5) provide that if a spouse’s income arises from a ‘settlement’, it is deemed to be the income of the other spouse. If one spouse receives income for activities carried out by the other, this rule applies.
It does not apply for: (1) unmarried, cohabiting couples; or (2) married couples where the income arises from an ‘outright gift’ (i.e. not subject to conditions, or reclaimable) (ITTOIA 2005, s 626).
There are two additional conditions for the exception to apply: (a) the gift ‘must carry a right to the whole of the income’, and (b): the gift ‘is not wholly or substantially a right to income’.
If one spouse receives a variable second income, a 50:50 split is no longer tax-efficient, and adjusting their shareholding is an inadequate solution. Theoretically, dividends could be waived to allow the other to withdraw more dividends.
A deed of waiver must be properly executed, signed by the shareholder and witnessed, before being returned to the company. The waiver must be in place before the dividend is paid. Proper planning is advised, as HMRC may challenge any waiver that is not made for a real business
Share splits are most tax-efficient when one spouse is non-earning, but if you and your partner have multiple income streams, strategizing can become more complicated and it is recommended that you consult a tax adviser.