Income Shifting – What is it?

| 24th September 2013

So called ‘income shifting’ is a method of tax avoidance designed to best use the various allowances and thresholds available to minimise your tax liability. If you or your partner is operating through a limited company, then you may not be taking full advantage to minimise your total tax bill.

The basic principle is best illustrated with an example:

Jack and Jill are married. Jack works as an IT Contractor through his own limited company, of which he is the sole director and shareholder. Jill takes care of their son, Ben, and has a part-time job. She also does some of the admin for Jack’s company.

John pays himself a salary, and takes an annual dividend. In order to take more money out of the company, Jack’s accountant recommends that he gives some of his shares to Jill, so that she can take dividends. He also suggests that since she does some of the admin for the company, she takes a salary from the company.

Caution should be used if you consider this method yourself. Although still allowed by current regulation, if the transfer of shares is deemed a ‘settlement’*, it may not be allowed. In the past few years, HMRC has been cracking down on possible breaches, although with mixed luck.

Two particular cases are worthy of note;

Garnett vs Jones (re: Arctic Systems) [2007]

Mr Jones bought a company, Arctic Systems Ltd, and gave one of the two shares to his wife. Mr Jones worked as a consultant, and Mrs Jones did some administrative work. Both received minimal salaries but large dividends.

HMRCs argument was that Mrs Jones remuneration was disproportionate to her contribution to the business, constituted a settlement, and was taxable as Mr Jones’ income. Mr Jones appealed, contending that a) the distribution of the profits from the company did not constitute a settlement, and that the transfer of share to his wife was an ‘outright gift’.