Update on Section 660 from Peter Vaines; Tax expert

Extract from Haarmann Hemmelrath UK TAX BULLETIN. This is to be published in April of this year after the Revenue published their examples

WIVES SHAREHOLDINGS

As expected, the Inland Revenue have now published a statement in Tax Bulletin No. 64 explaining their views about how the settlements legislation in Sections 660A to 660G Taxes Act 1988 apply in a business context.

It may be remembered that the focus was particularly on the position where a husband gives shares in the family company to his non working wife enabling her to receive dividends tax free up to the higher rate threshold. Section 660A provides that where a person makes a settlement (which includes making a gift of property), any income arising from that property will be taxed on him if the income could become payable to him or his spouse. Section 660A(6) provides a special exemption to exclude from these provisions an outright gift by one spouse to another unless the property given is wholly or substantially a right to income.

The sensitivity surrounds the suggestion that where ordinary shares in the family company are given by one spouse to another (particularly in a company where the donor does most of the substantive work), this represents a gift that is wholly or substantially a right to income so the dividends to the wife remain taxable on the husband.

Whilst this approach is fair enough in the case of preference shares, it cannot sensibly be applied to ordinary shares. Such shares are not wholly or substantially a right to income. Ordinary shares represent a bundle of rights, including the right to capital and the right to income is not the most important.

In their statement the Inland Revenue explain their position in broad terms and then provide fifteen examples dealing with various different situations. Most of these examples are entirely unobjectionable covering various ways in which income can be transferred gratuitously from one person to another. However, example 4 is a little different. In this example an IT consultant operating through a company gives 50% of the shares to his wife who is company secretary. She receives a small salary and the substantial dividends are divided equally between them. In these circumstances the Inland Revenue consider that the gift of the ordinary shares is wholly or substantially a right to income "since the capital value of the company is insignificant". Whatever other arguments there may be available to the Inland Revenue this one must surely be wrong.

Example 4 can be contrasted with example 10 where a husband gives a small shareholding in a public company to his wife who then receives all the dividends. They acknowledge that this is an outright gift of shares which is not wholly or substantially a right to income because the shares "have a capital value and can be traded, so the settlements legislation does not apply".

Example 11 provides a different take on the situation. In this case the husband owns all the shares in the small manufacturing company and gives half the shares to his wife who plays no part in the business. They receive dividends on the shares equally. The Inland Revenue accept that in these circumstances the shares cannot be regarded as wholly or substantially a right to income. The reasoning is that the shares have capital rights and the company has substantial assets so on the winding up or the sale of the business the shares would have more than insubstantial value.

It seems that the Inland Revenue are taking the simple view that unless the company has a value independent of the work provided by the husband, the shares should be regarded as wholly or substantially a right to income. This is an extraordinary approach. A company which makes profits sufficient to pay significant dividends is clearly valuable but for some reason that does not count. Maybe they think that the company would not be so valuable if the husband no longer provided his services. That would be the case with many companies; if they lose their key employee or employees the profits evaporate. So why should it matter if the husband (who will normally be bound to the company by an exclusive contract) is the person whose efforts provide the profits. This may be relevant to an argument about bounty but it is not relevant to whether or not the shares are wholly or substantially a right to income.

In any event this is much too simple an approach. A holding of ordinary shares is not wholly or substantially a right to income whatever the nature of the company. It is a bundle of equity rights which includes the capital value on a winding up or sale. Why should a one man band not be extremely valuable; the Inland Revenue certainly argue that it is when shares in such a company are transferred to the next generation, for example for inheritance tax or capital gains tax purposes. The holder of a 50% or less shareholding in a company does not have a lot of rights to receive income; dividends are either paid or recommended by the directors and approved by the shareholders in general meeting. A shareholder without control has rather limited rights in trying to obtain income. If she is married to the other shareholder this may make it easier, but this is to introduce a much too subjective test. The question whether shares are wholly or substantially a right to income cannot depend upon the holder and the identity or configuration of the other shareholders. It must be a matter which is capable of being determined objectively.

I think the Inland Revenue are going to have some serious difficulties with this argument now that they have articulated it publicly. However, for those wanting an easier life, there is always the opportunity to avoid the problem completely by use of Section 282A TA 1988 as explained in the February bulletin.

My thanks to Peter for his permission to publish this extract from the April, Haarmann Hemmelrath UK TAX BULLETIN