Sharing income in the family company

 

It is no secret that the most tax efficient way of carrying on a business is through a limited company.  For the majority of small or start up businesses, the savings in national insurance alone will more than cover the additional costs of running a company.  For established businesses, the fact that retained profits are taxed at 21 per cent to 28 per cent instead of 41 per cent results in further savings.

 

Married couples

 

But it doesn’t stop there.  Married couples and civil partnerships can make use of two sets of personal allowances and basic rate bands to draw up to £86,000 a year between them without paying higher rate tax, or £300,000 a year without paying the new 50 per cent additional rate. This can be achieved through a simple gift of shares, so that dividends can be paid to both spouses.

 

Non-married couples

 

What about non-married couples?  Their position is not quite as straightforward.  Take, for example, a one-person consultancy company, where all the profits are generated from a single person. Sharing the dividends 50:50 with an unmarried partner would be caught by anti-avoidance legislation, resulting in all the dividends being taxed on the working director. However, where the earning capacity of the company is more of a ‘team effort,’ involving several employees, trading premises etc, the anti-avoidance rules are less likely to bite. With care, the same tax savings can then be achieved.

 

Adult children

 

Taking matters a stage further, we can also consider giving shares in our ‘team effort’ company to adult children. As university fees are set to escalate, it could well make sense for income to be received in the child’s name, making use of his or her tax allowances, to save higher rate tax. It is important to note that this requires the child to be 18 years old or more, and that an outright gift is made. If the thought of giving one’s ‘not-yet-entirely-trustworthy’ offspring a stake in the family company is too frightening to contemplate, the shares may instead be held in trust for them, and transferred at a later date.

 

HMRC Opinion

 

What do the Revenue make of this?  They have fought and lost two cases in this area in recent years, and drafted legislation to counter what it calls ‘income shifting.’  The Labour government shelved these plans two years ago, and the new coalition government has said nothing more than it is ‘reviewing small business taxation.’ We await the Budget on 23 March 2011 to find out their plans.