In my article of three weeks ago (which I wrote in happier times – I
had not yet spent a miserable Saturday afternoon at the Reebok
Stadium and a predictably disappointing Sunday watching on TV as
Sperz rolled over against the Mancs) I looked at the worrying reports
of increased Inland Revenue antagonism towards the payment of
dividends to shareholders in private companies who do not work full
time in the business and who are related to shareholders who do work
full time in the business – the most obvious example being
The basis of the Revenue's argument is understood to be that there
could have been a settlement of income and so the spousal exemption
from the anti-avoidance provisions would not apply. If the argument
is successful, then the dividends received by the non-worker would be
assessed on the working shareholder, in other words, the settlor. The
argument could also be used to assess partnership income, that is,
share of profit, accruing to a non-working or undercontributing
partner on the full-time working partner.
All very worrying and all very relevant to anyone advising private
businesses on tax and financial planning. But there's more.
In its latest Tax Bulletin, the Inland Revenue gives some very useful
additional guidance to its thinking on the important subject of the
application of the settlements legislation in sections 660A-660G ICTA
The Tax Bulletin is quite comprehensive and provides:
Helpful clarification on what could be caught and
Some welcome reassurance on what will not be caught.
Nevertheless, it reinforces the fact that there are circumstances
where the settlements legislation can apply to husband/wife
businesses, incorporated or unincorporated.
The Tax Bulletin (an excellent publication) starts by stating that,
in general, “the settlements legislation can apply where an
individual enters into an arrangement to divert income to someone
else and in the process tax is saved. So long as those arrangements
Not commercial or
Not at arm's length or
In the case of a gift between spouses, wholly or substantially
a right to income.”
So how does the legislation apply to non-trust situations?
A very small percentage of the enquiries currently undertaken by the
Revenue each year involve the settlements legislation and non-trust
situations. However, the Revenue does seek tax, interest and
penalties in appropriate cases. It is not possible to provide a
definitive list of the issues the Revenue looks for when deciding
which cases to take up for enquiry but some of the factors that it is
looking for might include:
Main earner drawing a low salary, leading to enhanced profits
from which dividends can be paid to shareholders who are friends or
Disproportionately big returns on capital investments.
Differing classes of shares, enabling dividends to be paid only
to shareholders paying lower rates of tax.
Dividends being waived so that higher dividends can be paid to
shareholders paying lower rates of tax.
Income being transferred from the person making most of the
profits of a business to a friend or family member who pays tax at a
There are a wide range of arrangements that can potentially be caught
by the settlements legislation which do not involve a trust. Each
case will depend on the facts but some of the most common situations
which are seen by the Revenue are:
Shares subscribed at par that carry only restricted rights.
Shares given away that carry only restricted rights.
Shares subscribed at par in a company by someone else where the
income of the company derives mainly from a single employee.
A share in a partnership gifted or transferred below value.
Situations where dividends are paid only on certain classes of shares.
Dividends paid to the settlor's minor children.
This list is by no means definitive of situations to which the
settlements legislation can be applied.
So, let us look at some examples of situations where, according to
the Tax Bulletin, the legislation (in the Revenue's opinion) could
apply. The Tax Bulletin gives plenty of examples. Here are a few of
them which I believe will be helpful to readers.
Issued shares with restricted rights
An engineering company has 100 ordinary £1 shares. Mr A and Mr B
own 50 ordinary shares each. They create a new class of B shares
which carry no voting rights and no assets in a winding-up.
They issue 50 B shares to each of their wives. Dividends voted on
those B shares would be treated as the income of Mr A and Mr B rather
than their wives as the B dividends are from shares that are wholly
or substantially a right to income and so not exempted from section
660A by section 660A(6).
This example is based on the High Court case of Young
Scrutton  STC 743.
I will continue this article next week, by which time the Premiership
will have been decided, if it hasn't been before then.