Revenue's Section 660 attack on married couples
The Revenue’s attack on married couples has now hit the headlines although it has been brewing for some time now. It was 18 months ago since Geoff and Diana Jones, of Artic Systems Limited, first contacted Qdos Consulting. Qdos' Steve Greenwell agreed to try and help them deal with a problem they had with the Revenue regarding the taxation of dividends which Mrs Jones had received as a shareholder in Artic. Since then Qdos have gained two more cases and Accountax are also involved in similar cases.
Section 660 ICTA 1988
In simple terms the Revenue are arguing that, under tax legislation designed to prevent the avoidance of tax by transferring assets to taxpayers with lower marginal tax rates, they are entitled to regard the dividends received by Mrs Jones as being the income of Mr Jones, to be taxed at his highest rate. The impact for the Jones of the application of this view, going back several years, is about £40,000 in extra tax.
The legislation is contained in section 660 of the Income and Corporation Taxes Management Act 1988. It has never previously been used to challenge situations where the shareholder has subscribed for shares in the company right from the start, rather than being gifted shares previously owned by another shareholder.
The Revenue’s new approach
The Revenue now appears to be arguing that, although the shares were not gifted, the dividend is not really received as a right by virtue of the shareholding, but by virtue of the working spouse, who earns most of the business’s income, agreeing to take a minimal salary and thereby bestowing a bounty upon the other shareholder.
Even in situations where the first spouse gifts shares to the other spouse it was always considered that a specific exemption for gifts between spouses ensured that the Revenue could not challenge the treatment of the dividends. However, the Revenue is now also arguing that this exemption does not apply because the shares are wholly or substantially a right to income.
The Implications
The implications of this attack on the status quo are immense. It could apply to freelancers who might escape IR35 by passing the IR35 tests. It can also apply to the many small businesses that are not affected by IR35 because they do not supply personal services. The criteria will be whether the second shareholder/spouse receives dividends that are in excess of what the Revenue considers to be a fair salary for the contribution they make to the business.
Tax professionals are surprised that the Revenue has decided to change the application of Section 660 to family companies without having given any warning or any form of guidance as to how they intend to interpret and apply the rules. There is nothing to say what constitutes a “reasonable reward” for a spouse, who may only work part time in the business. As with IR35 taxpayers are again faced with great uncertainty under which they must somehow file their self-assessment tax returns.
The revised policy also seems strangely at odds with the way that tax legislation allows and encourages married couples to transfer assets (and the associated income) between themselves with no capital gains or inheritance tax consequences. It seems unfair and illogical that a freelancer can pass shares in a quoted company to their spouse where future dividend income will be taxed as that of the freelancer’s spouse. But transfer shares in their own company and the freelancer could still be taxed on all or most of the income.
This issue looks set to run and run. It will be interesting to see if the Revenue tries to apply their new approach to family businesses that are not service businesses and therefore potentially affected by IR35. Unless they do it would appear that this new move is mainly designed to ensure that many of those freelancers, who have managed to arrange their business affairs so as to fall outside IR35, could still find themselves caught by swingeing new taxes.