Last week, I restated some tax planning fundamentals for couples but I
also sounded a warning that there are some traps to be aware of, especially
where the objective is the transfer of earned income where one or both of
the couple have control over the means of producing the income.
Before rushing to make such transfers, it is important to remember that,
in order for the payment to be deductible for the payer (regardless of
whether that payer is a company, an individual or partnership), the same
Schedule D rules apply and the payment must be incurred “wholly and
exclusively for the purposes of the trade, profession or vocation”. The
importance of this cannot be overstated.
Non-deductibility for the payer will mean not only that the income remains
assessable (in effect) in the higher tax base but that the income will also
be assessable on the recipient. Now this may well mean that no additional
tax liability is triggered if the recipient is a non-taxpayer but no
improvement in the taxsituation of the couple will have been achieved.
Thus, it is important to ensure that deductibility is secured. In order to
do this, it is important that, broadly speaking, the work carried out is
commensurate with the payment made.
Of course, in addition to this, the payment should actually be made in
respect of an employment that formally exists. In other words, the payment
should be made in form as well as substance.
Where the paying business is a partnership then, where the payments to the
spouse are more substantial and there is some concern over deductibility,
consideration may be given to bringing the spouse into the partnership. If
this is considered, it is worth remembering that the new partner must be
admitted properly into the partnership.
The Inland Revenue's attitude to this is indicated in its Inspectors'
Manual 263. In particular, it states that: “It is worth emphasising that
the partnership is not a sham merely because of it is set up to save
tax Cases which are worth investigation are more likely to be
found among those in which there is no current partnership deed.”
It is important that the partnership should be one not only in substance
but also in form. Turning quickly to the “substance” part of the “substance
over form” consideration, perhaps more worryingly, there has been evidence
recently that the Revenue has sought to impose the provisions of section
660A ICTA 1988. This would be on the grounds that there has been a
settlement of income which is not exempt from the anti-avoidance provisions
on the grounds that it is between a husband and wife.
The Revenue could, in these circumstances, argue that if the spouse does
not substantially work in and contribute to the partnership, then the
income that the spouse is entitled to by virtue of the partnership interest
is nothing more than a settlement of that income by the substantially
involved partner and the spouse's profit share would be assessed on the
substantially involved partner.
This risk is thought to be less when the spouse is a partner from the
commencement of the partnership but it is one that needs to be taken into
Where the business considering the move is a limited company and where
there is concern over the deductibility of the proposed payment, then
another way around this may be for the recipient spouse to become a
shareholder and receive dividends which will not be chargeable on the
“wholly and exclusively” grounds. Where this route is considered, thought
should also often be given to issuing a different class of share that
perhaps carries restricted rights, for example, shares that carry the right
to dividends only since it is an ability to pay dividends that gives rise
to the desire to issue shares.
If such shares are considered, one needs to take into account the
potential for a similar attack being made by the Revenue as was described
above in respect of the partnership idea, namely, that there has been an
effective settlement of income. This attack can be pre-empted, of course,
by ensuring that the shares participate in more than just dividends.
It is, of course, impossible to transfer or assign rights under approved
pension arrangements. This makes it essential to create pension rights for
each of a couple so that the income generated from the pension fund is
properly split so as to maximise use of tax allowances and lower tax bands
This means that when considering payments of income to each of a couple
from a business, it is also important to consider pension arrangements for
them. Generally speaking, pension contribution capability (occupational or
personal) is determined by the amount of money available to make a
contribution and the salary/profit level of each of the couple.
The big exception to this rule is the ability for a contribution to be
made to a stakeholder pension arrangement in respect of an individual
regardless of that individual's salary level provided the amount of the
contribution does not exceed £3,600 gross or £2,808 net of
basic-rate tax each tax year.
The tax-effectiveness of making such a contribution where the funds used
to make it, if not used in this way, will have been taxed at a personal or
corporate tax rate, makes the attraction even greater.
Of course, going back to my original point, the fact that the pension
arrangement will then belong to the person who has made the contribution or
had the contribution made on his or her behalf will mean that the income
generated from the resulting pension fund will be assessable on that
person. This will possible give scope for the use of that person's personal
allowance in retirement so that the pension may well be wholly or
substantially free of tax.