A recent case shows that HM Revenue and Customs (HMRC) will seek to apply legislation relating to settlements if it suspects tax avoidance by ‘income splitting’. The decision highlights the need to take advice where various classes of shares are created.
The dispute involved a husband and wife who had each invested half the money required to set up a company. They set up a share structure that involved the creation of different classes of shares, which had different rights and different entitlements to dividends.
The couple agreed that the wife would receive far fewer ‘A’ shares than her husband in return for her investment. However, she was also issued with some ‘B’ shares, which received dividends in their own right. The husband had day-to-day control of the business but the wife stood to receive far larger dividends than he did. These dividends were paid to her, but on the understanding that they would be paid across to her husband in order to repay loans taken out to purchase another business. They were both jointly liable for these loans. This complicated the situation somewhat.
HMRC argued that the arrangement was ‘income splitting’ and the effect was to set up a ‘settlement’ for the wife. Income tax assessments were raised to assess the wife’s income as if it were her husband’s.
The court agreed to some extent with HMRC’s argument, but did not find anything uncalled-for in relation to the ‘B’ shares, as the returns on them were less than the wife’s investment warranted. The increase in the tax payable as a result of the court’s decision was £6,000, considerably less than HMRC sought.
This case shows the robust approach that HMRC will take with regard to such schemes. If you would like advice on any aspect of share structure, we can assist you.