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Income splitting – another HMRC attack

23.04.2011

A recent case involving a ‘multiple shares’ company, in which different classes of shares were created, with different rights and varying dividends paid to the shareholders over time, illustrates the baleful look that HM Revenue and Customs (HMRC) gives to such schemes.

A husband and wife had set up the share structure when they bought a business, each of them investing half the money required.  The agreement was that in return for her investment the wife would receive far fewer ‘A’ shares than her husband (who had day-to-day control over the business) and not be in a position of responsibility in the company. However, she stood to receive far larger dividends than he did, because she was also issued with ‘B’ shares which could (and in the event did) receive dividends in their own right.  The position was complicated by the fact that the dividends were paid to her on the understanding that she would pay them across to her husband.  The dividends she passed across were used to repay loans (for which they were both jointly liable) taken out to purchase the business.

HMRC argued that the arrangement was ‘income splitting’ and the effect was to set up a ‘settlement’ for the wife.  Accordingly, various Income Tax assessments were raised to assess the wife’s income as if it were her husband’s.

The court’s decision upheld HMRC’s argument, but only in part, the judge ruling that there was nothing gratuitous in the issue of the ‘B’ shares on the basis that the wife’s investment warranted more than they were worth in return.

As a result, the net gain to HMRC is about £6,000 in extra tax – considerably less than originally sought.

The case does show, however, that HMRC will seek to apply legislation relating to settlements if it suspects income splitting, and illustrates the wisdom of making sure that where various classes of shares are created, this is done with the benefit of expert advice.

HMRC have recently announced their intention to appeal against the court’s decision.

We can advise on all aspects of corporate share structure and shareholders’ agreements.  Contact Richard Cripps, Partner at [email protected].

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