Although it is difficult to provide full advice until any new legislation/guidance is issued, there are a series of steps you can take to reduce the risk of potential income shifting.
1. Ensure your second shareholders have the right sort of shares - that is, ordinary shares with rights to vote and to capital.
If your second shareholder is your spouse you are able to transfer the share(s) between yourselves without incurring any tax liabilities. If your second shareholder is not your spouse, any transfers of share(s) may give rise to Capital Gains Tax and/or Inheritance Tax if there is any growth in the value of the shares.
2. Get the paperwork right.
In order to prove that the director(s) of the company considered and voted for a second shareholder and considered the dividend split between the two shareholders, it is important that adequate documents are completed and retained. In one case HMRC won purely because of lack of paperwork by the taxpayer.
3. Document the initial dividend split and stick with it.
The split of dividends between you and your second shareholder should be agreed and documented at the date the shares are issued. The timing and frequency of changes to the dividend split with your second shareholder will also impact on the risk of HMRC successfully challenging the arrangement. For example, frequent changes throughout the year and/or a final change towards the end of the tax year may indicate to HMRC that mitigating tax is the sole reason for the arrangement.
Do not pay excessive dividends to your second shareholder. The higher the proportion of dividend paid to your second shareholder the more chance HMRC may choose to challenge the tax position. We would not recommend that the split exceed 50% in favour of the second shareholder.
4. If you need to change the split, document the reason and be careful to continue to get the dividend paperwork right.
Always document any subsequent changes to the dividend split. If you wish to change the dividend split during the year, as is common practice in many family owned companies, you must document this by ensuring the dividend split on the dividend vouchers represents the revised split. Do not change the dividend split retrospectively. We would never advocate the change/allocation of a dividend split after the tax year has ended or after a dividend has been voted/paid. This is clearly tax avoidance.
5. Record your second shareholder’s contribution to the business.
Consider and record commercial reasons for the appointment of the second shareholder and any changes to the dividend split. HMRC is also likely to look at the purpose of the second shareholder arrangement. For example, if it was determined that this was solely to use up the second shareholders’ lower rate tax bands and you were still able to benefit from the dividends paid then they are more likely to argue the arrangement is a “sham” and no gift actually took place. If you are able to demonstrate that your spouse made a meaningful contribution to the running of the company your position would be strengthened, as you would be able to demonstrate a commercial arrangement was in place. Your second shareholder probably does support you in the business. Putting some notes on this in the documentation of the split will help convince HMRC of the commerciality of your agreement.
If the second shareholder’s commercial contribution to the business increases this could support an increase in their dividend share. They do not need to be able to carry on your profession to be of commercial benefit to the business, partners can provide assistance with administration or financial management.
The efforts of a non fee-earning shareholder should be documented clearly to emphasise the commercial basis of the arrangement. Regular changes to the dividend split without corresponding changes to the commercial contribution of each shareholder would be viewed by HMRC as aggressive tax avoidance.
If shares are issued as part of a commercial arrangement and the second shareholder is also an employee/director of the company there is some anti-avoidance legislation that deems the dividend to be disguised remuneration and therefore seeks to tax dividends received by the second shareholder as salary. This point is at yet untested but is another potential risk for you to bear in mind when deciding whether you appoint a second shareholder.
6. Ensure the dividends paid to your second shareholder are for their benefit and not yours.
Consider a gift without retaining an interest. In this context, a gift includes allowing your second shareholder to subscribe for shares in the company at face value (as opposed to their actual market value).
Retaining an interest in this context would mean you still benefiting or being able to obtain benefit from the share and could therefore be taxed on the dividends paid to your second shareholder. Particular situations that would significantly raise the risk in this regard are:
- Both dividends being paid into a bank account in the single name of the first shareholder;
- An agreement between shareholders (either formally or by practice) that any second shareholder income was returned to the first shareholder.
To avoid this the dividend should be paid into an account in the name of the shareholder, over which they have control and the dividend monies paid to the second shareholder are not used by or benefit the other shareholder.
Paying dividends into joint accounts should be avoided. HMRC has not indicated whether they feel there is a retained interest where the income from both shareholders contributes to the running of the household if they are married or cohabiting.
Where the dividends are paid into the bank account of the second shareholder and the dividend monies received are used for the direct benefit of the primary shareholder, HMRC could argue that the dividend should be taxed on the primary shareholder.