‘Married couples’ tax: For better or for worse?

The Revenue has stated that in certain situations it will seek to use what is known as the ‘settlements legislation’ to reallocate income where it believes it has been diverted to save tax. This reallocation will result in the Revenue seeking back tax plus interest and penalties, which could run into several thousands of pounds.

Small family businesses are often run with one or more person doing the work and their spouses providing some basic administrative support and a lot of less quantifiable background assistance. For example, Mr Jones may be the sole shareholder in his own company. He meets the woman of his dreams, gets married and decides to give her a half share in the business.

She helps with the books but he does the majority of the work. He is a higher rate taxpayer and she pays tax at the basic rate. They pay themselves primarily in the form of dividends, as this is encouraged by the tax system which makes this a more efficient way of extracting funds from a company.

On the basis of the Revenue’s recent interpretation it could seek to reallocate sums received by the wife and treat them as if they were the husband’s income. He being a higher rate taxpayer, there would be more tax to pay and if the arrangement had been in place for sometime, the Revenue could seek tax relating to previous years. It would also look for interest and penalties on any overdue tax.

The reasoning behind the Revenue’s interpretation is rooted in laws dating back 70 years – so the Revenue can fairly claim that elements of its argument are hardly new. The settlements legislation says (in section 660A, ICTA 1988 if you want to see the chapter and verse) that certain arrangements will be caught which are essentially non-commercial, bounteous, not at arm’s length and when it comes to gifts between spouses are ‘wholly or substantially a right to income’. If someone falls within these categories they may find the Revenue wants to take a closer look at their tax affairs.

Few would argue with certain examples found in the Revenue’s tax bulletin which outline the law as it is generally understood. For example, where there are differing classes of shares that allow only shareholders, who pay lower rates of tax to receive dividends, there is case law to support a Revenue attack.

More concerning is the type of situation outlined in the Mr and Mrs Jones example above where the less active spouse holds ordinary shares which arguably are far more than just a right to income in the business, but are a more extensive bundle of rights. Mrs Jones appears to have a stake in the business that is much more than just an income stream.

Certainly if the happy couple ever divorced she would be arguing her entitlement to at least half if not more of the business.

The examples the Revenue offers in its bulletin (and there are 15 of them) are far-reaching and cover not just husbands and wives but transactions involving children, family members and a range of business structures, including partnerships. While it is useful to see the Revenue’s view, many of the situations it outlines appear to go much further than most tax advisers would have expected. They are already raising concern with businesses and individuals, who have taken reasonable tax planning steps which they would not have expected to fall within the settlements legislation.

One striking element in the example is the emphasis put on the situation of the business today and its current capital value without any consideration of what may happen to it in the future and how it may grow. The tax bulletin is just an interpretation; it is not law and it is highly likely that test cases will follow to challenge some of the stated views.

In the meantime those potentially affected are looking at what action they should be taking now. As is often the case, the right action will depend on the facts of each case. Some will be confident that they fall outside the ambit of the settlements’ legislation and will have strong arguments and evidence to repel any Revenue questions.

Others may decide that they wish to take action to bolster their position – perhaps by looking to enhance the capital value of the business by retaining more funds within it or reconsidering the ownership structure of the shares.

But until we have definite case law on the issues raised by the Revenue’s tax bulletin, we have the situation least useful to taxpayers, uncertainty.

  • Francesca Lagerberg is national tax director at Smith & Williamson.
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