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A new twist to income shifting

16 July 2015
Income shifting

It’s now seven years since HMRC lost its epic court battle over income shifting in the now infamous Arctic Systems case. Despite threats that it would have its revenge no new legislation has been introduced to neutralise the tax advantage that can be gained by transferring shares in your company to your spouse. It has again become standard tax planning in the right circumstances.

Tax rate differential

The plan is straightforward. If you’re a higher or additional rate taxpayer and your spouse pays at a lower rate, shifting some of your income to them will result in a lower joint tax bill. Assuming you run your business through a company, a simple way to achieve this is to transfer shares in your business to your partner. In future when your company pays dividends some of what would have been taxed on you is taxed on them instead.

Transferring the shares

First decide on the number of shares to transfer taking account of how much income you want to shift now and in the future. The usual plan is to then give the shares to your spouse (so no money changes hands), but we have a cunning plan to make the arrangement more tax efficient. Tip. If you have a mortgage on your home, instead of giving shares to your spouse sell them.

Why sell instead of giving?

Tax relief for interest paid on home mortgages hasn’t been allowed for many years, but subject to conditions (see below) interest on loans to purchase shares in a company does qualify. So if your spouse converts your mortgage into a loan to purchase shares they can claim tax relief at up to 45%, i.e. the current top tax rate.

Putting the plan into action

The first step in our plan is to extend your mortgage for a short term only. Alternatively, you could take a bridging loan and then remortgage. The second step is for your spouse to use the new borrowing to buy shares from you. Now you have the money in your bank account the final step is to use it to repay some of the mortgage. You have now converted your home mortgage (or some of it at least) into a tax-qualifying loan to buy shares in a company.

Conditions

For the scheme to work a few basic conditions must be met:

  • your company must be a trading company, i.e. its business must not mainly consist of holding investments

  • you must sell at least 5% of the company’s total ordinary shares

  • the sale price of the shares shouldn’t be more than their market value, i.e. what you would get if you sold them to a buyer who had no connection to your company.

No CGT either. The final good bit of news is that special rules apply to transactions between spouses. So even where you sell the shares to your spouse for more than they cost you, no capital gains tax is payable.

If you have a home mortgage sell shares to your spouse instead of giving them away. Refinance your home so that your spouse can use the funds to pay you for the shares. You can use this to reduce the original mortgage. The interest on the new borrowing qualifies for tax relief whereas that on the original mortgage didn’t.

 

 
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