Among the benefits of Limited Companies is the fact that as a Limited Company Director you can enjoy further tax efficiency and save money by making your spouse a shareholder in your Limited Company.
Your spouse must earn less than the basic rate tax threshold for you to get the full benefit.
The relief comes through using your spouse’s dividend allowance. The first £5,000 that a company shareholder receives is tax-free, and the dividend income a shareholder receives is taxed at 0% for the 2016/17 tax year. If your spouse is earning less than the basic tax threshold, dividends over £5,000 up to the threshold are taxed at the lower rate of 7.5%.
What are the risks?
You may be worried about tax avoidance and how HMRC will view this. It’s true that HMRC does tend to be suspicious of agreements such as this, depending on the circumstances. For example, a spouse being paid a salary to help reduce business profits (and thus taxable income) or allocating shares to a spouse that can then be paid out as dividends often invites questions.
However, if your spouse pays tax at a lower rate than you, then forming a business partnership with them is a viable and legitimate way to split business income. It’s still possible to do this if your spouse has another income, however this requires careful planning - their dividends pushing them over the basic rate will make the whole agreement inefficient.
For this to be accepted by HMRC, your spouse needs to be entitled to a share of capital assets in addition to profit.
For your spouse to be entitled to a share of capital assets and profit, they should be contributing to the business, either through the contribution of capital or other assets of value, or by providing services where they are unpaid or paid below the market rate. You can prove their entitlement to HMRC by drawing up a partnership agreement.
Bear in mind that HMRC can limit tax relief in the case of partnership losses. Certain rules limit income tax loss relief for business partners who are either not active or have limited input into your business.
How Do I Allocate Shares?
A common method of allocating shares is the ‘gifting’ of ordinary shares to your spouse. Here, shareholders receive dividends in direct proportion to their shareholdings.
You can also issue ‘alphabet shares’, which involve different classes of shares (A Class, B Class, C Class - hence the name!) and setting different rights and rules for different share classes - allowing you to pay dividends at a variety of amounts, and at different times. However, please note that HMRC do see these as representing a higher risk, and may ask for the reasons behind you setting up shares in this way.
The costs involved in making your spouse a shareholder in your Limited Company may include:
- Company Valuation
- Change of share capital (in relation to the change with shareholding) with Companies House
- The passing of a resolution
- Transfer duty to HMRC at 0.5% of fair value above the transfer duty threshold
Although adding your spouse as a shareholder can certainly have its benefits, we strongly recommend you do it thoroughly, ensuring you have valid reasons behind the structure you select.
It always makes sense to talk to a tax expert - if you need any help considering your options please just get in touch for a free consultation!