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You are a sole trader and want to incorporate a new limited company. Structuring a business in a new limited company is good in certain circumstances. Most of the time, a spouse is added as a shareholder in the company to reduce tax bills. This may be an excellent way to handle this situation regarding taxes or a terrible thing to do.
Dividing your Income: Fifteen years ago, the House of Lords’ verdict in the Jones and Garnet case (commonly known as the “Arctic System Case”) was reversed. In this case, HMRC attempted to close the tax-saving arrangement frequently used by husband and wife in closed companies. However, the judgement was overturned. Instead, the Lords decided whether or not one spouse was liable for taxes on dividends received by the other spouse when only one spouse was responsible for the company and only one spouse was working.
Tax Savings: The following example explains why HMRC was so confident that the spouse generating income should be taxed on all dividends paid by the company.
Example. Because Bill and Ben are married or civil partners. Bill is working as a consultant on a freelance basis for a business through his Limited Company. He forecasts an annual profit of £170,000, which, after the deduction of corporate tax, will come to a total of £137,700. Ben is currently without a job at this point in this period. If Bill were to hold all of the company’s shares and get all the dividends, he would have an income tax liability of around £37,000 (using rates that would be in effect in 2022/2023). However, if they both held fifty per cent of the company’s shares, they might jointly divide the income and pay a tax bill that was little more than £18,000, saving almost £19,000.
Question: Some couples and their tax advisors are unduly cautious or careless in splitting dividend income, missing out on substantial tax savings or getting caught by anti-avoidance provisions that cancel out any potential tax savings. Spouses or civil partners must hold shares when the company is formed or if shares are transferred during a particular year seems to need clarification. In practice, dividends can only be issued if a person holds a share in the company. Both techniques mentioned above can be adapted to split dividends, but specialist advice should be sorted if shares are transferred during the year.
It can be tricky to plan how many shares each spouse should own to achieve maximum tax efficiency because the company and the spouse’s income are likely to fluctuate yearly. Consider issuing alphabet shares to each spouse so that the dividends received by each can be customized.
If you are a contractor and looking for advice on how Limited Company and Dividend Tax please call our office on 08001357323 for specialist advice.