If you’re married or have a civil partnership, and your spouse doesn’t have a paying job, then you can make use of a useful tax-saving device called income splitting.
You can do this by structuring your income so that both you and your spouse can use your tax free allowance and basic rate of tax – a big saving compared to paying higher rate tax on the same amount.
By setting up a company, making both you and your spouse directors and giving out equal shares of the company, you can both take dividends and pay less tax. It may seem complex but ContractingWISE works with some excellent accountants who can help you through the fine details.
S660 rules on settlements
Naturally, HM Revenue and Customs would prefer it if people did not split income, as it reduces their tax take. HMRC has employed legislation known as S660 that is designed to stop incoming splitting or income shifting.
S660 – the shorthand term remains common although S660 was superseded by Section 624 of the Income Tax (Trading and Other Income) Act (ITTOIA) 2005 – says that if contractors make a ‘settlement’ then it should still be treated as being taxed at the original rate.
The Arctic Systems test case
HMRC’s anti-income splitting stance was tested in court in 2007. The tax authorities fought a lengthy court battle over S660 with IT contractor Geoff Jones and his wife Diana in 2007. Mr Jones had given his wife shares in Arctic Systems, but HMRC said the dividends should be taxed as though he owned them ie at the higher rate.
The House of Lords ruled in favour of the Joneses, which is good news for contractors.
However, despite the ruling there remain several hurdles to clear before attempting income splitting with your spouse, and not all accountants advise that you do it.
Hurdles to clear before income splitting
First, this only works for spouses as you can give shares to a spouse and they will not be liable for capital gains tax. Children or other family members would have to pay CGT which would potentially wipe out any income tax savings.
Secondly, accountants advise that the spouse should make an active contribution to the company, perhaps by doing the bookkeeping, paperwork, or booking clients. This should be backed up with records of time spent working for the company. The key is for there to be a ‘genuine commercial arrangement’.
And lastly, watch out for changes in legislation. The Government announced after the Arctic Systems case that it would be reviewing income shifting rules to stop the practice. This was postponed indefinitely in the 2008 Budget, but don’t rule out a future comeback.
For detailed advice that suits your circumstances, there is no substitute for a consultation with an accountant. ContractingWISE works with a wide range of excellent accountancy firms – get in touch and we’ll be happy to help.