You may recall that in the article before last, I dealt with the assessment of capital in determining an individual's contribution to care home costs. I was then distracted by reports of an upswing in Inland Revenue action against husband and wife companies, where both are shareholders and receive dividends. So as not to disrupt the flow again, I will finish my review of this news and then return to the care fees issue. OK?
Most commentators on this attack on spousal dividends have expressed surprise, especially where each of the married couple own ordinary shares that carry full rights to shares in profits/dividends and capital. The basis of the attack is S660A ICTA 1988. The most relevant parts read as follows:
660A(1): ” Income arising under a settlement during the life of the settlor shall be treated for all purposes of the Income Tax Acts as the income of the settlor and not as the income of any other person unless the income arises from property in which the settlor has no interest.”
600A(2): “Subject to the following provisions of this section, a settlor shall be regarded as having an interest in property if that property or any derived property is, or will or may become, payable to or applicable for the benefit of the settlor or his spouse in any circumstances whatsoever.”
660A(6): “The reference in subsection (1) above to a settlement does not include an outright gift by one spouse to the other of property from which income arises, unless (a) the gift does not carry a right to the whole of that income or (b) the property given is wholly or substantially a right to income.
“For this purpose, a gift is not an outright gift if it is subject to conditions or if the property given or any derived property is or will or may become, in any circumstances whatsoever, payable to or applicable for the benefit of the donor.”
Although the normal settlement anti-avoidance provisions (applying to assess income from settled property on the settlor where the settlor/settlor's spouse can benefit) do not apply when the settlement is made in favour of a spouse, this exemption will not apply where the settled property is wholly or substantially a right to income. As a pre-requisite to the settlement legislation applying at all, though, there must have been an “element of bounty” – something given for which there was no consideration provided by the receiving party.
The Revenue is targeting two main areas, both of which are fairly common. The first is where the husband and wife each subscribe for the shares at outset but work in the company is substantially, if not wholly, carried out by the husband. The second is where only one party, say, the husband, subscribes for the shares and subsequently makes a gift of shares to the spouse.
In the first case, especially with ordinary shares, it has hitherto been thought that there was no tax risk attached if the transaction were carried out properly. There would have been no gift by the husband (so no bounty) and the shares will not have been a right to income but a “bundle of rights” incorporating income and capital rights so that the gift would not have been wholly or substantially of income.
The Revenue believes that the shares themselves do not give rise to the income (dividends) but are merely the vehicle. It agrees that there is no bounty connected with the shares (they would have been subscribed for, not given) but does not agree that there has been no bounty.
According to the Revenue, there will have been subsequent bounteous acts by the “working shareholder” whose efforts generate revenue for the company but who decides not to draw a commercial rate of salary, preferring to increase the profits to be distributed by way of dividend. This benefits the “non-working” shareholder – the spouse of the “worker”.
The Revenue concludes that there is both bounty and the gift is substantially the right to income – the dividend. But its view is that the underlying source of the income is not the shares but the contracts and commercial arrangements that give rise to the income from which dividends are paid.
In the second case, there are gifts of shares. But even given the same work/no work split between the shareholders, it has been the view to date that what was given (the ordinary shares) is not wholly or substantially a right to income but a bundle of rights in the shares. The Revenue is arguing that what has been given is wholly or substantially a right to income.
This is a worrying development. The closest legal cases are those of Young Pearce and Young Scrutton (1996). In these cases – both decided in favour of the Revenue – there was the creation of a new class of preference shares carrying dividend rights equal to 30 per cent of company profits. It is not hard to see that what was given was wholly or substantially a right to income. The High Court held that the wives' dividends were the income of their husbands. It has been thought that, to avoid this risk, any shares given should be ordinary shares carrying full rights to income and capital.
This latest development is evidence that the Revenue is approaching this issue on substantially different grounds. It can only make its argument work if the property in relation to which there is bounteous intent is other than the ordinary shares themselves as these are not wholly or substantially a right to income. Remember, for the Revenue to succeed, it is necessary for there to be a bounteous act, that is, a disposal of property for which no consideration is given, and for the property gifted to be wholly or substantially a right to income.
There are enough businesses potentially affected for this matter to have to be decided by the judicial system. Watch this space.