Lee Sharpe looks at the rules for sharing dividends between spouses and civil partners.
In this article, I’ll look at how to ‘spread’ dividend income between spouses and civil partners in a couple, to maximise the tax benefit.
The usual scenario is that the shares giving rise to dividends will be in the family company, although this does not have to be the case; it could likewise apply equally to non-ISA shares in a portfolio.
The basics
It may seem logical to remove income from one individual who is paying tax at a high rate and transfer it to another (presumably close!) individual who pays tax at low(er) rates; but if there is one rule that applies consistently to tax, it is that while there is a degree of logic in almost all tax measures, it is not often the same logic or is not consistently applied.
It is mathematically possible to transfer income to another party and actually to be worse off as a couple, thanks to some of the ‘cliff-edge’ effects that now potentially apply to different levels and compositions of taxable income (such as when the so-called savings ‘allowance’ halves from £1,000 to £500 for higher rate taxpayers, or where the recipient is theoretically only a 40% taxpayer but starts to lose their tax-free personal allowance when adjusted income hits the £100,000 mark).
More basics
There are various thresholds and other criteria to keep in mind, including the following points.
The first £2,000 of dividend income should always be tax-free to the recipient; otherwise:
(Bands, etc., are for 2019/20, for the rest of the UK, outside of Scotland)
So for someone who is a higher rate taxpayer on his or her dividend income, and who then transfers £10,000 of that dividend income to their spouse or civil partner who will pay tax at only the basic rate, the overall saving will be up to £2,500 income tax a year across the couple.
Potential traps:
- If the recipient is liable to pay student loans, his or her effective tax rate will be increased by 9% once the relevant income limit is breached (the threshold varies according to plan type); from April 2019, the repayment could be increased by 6% if the recipient is also liable to repay postgraduate loans. If the donor is not liable to repay such loans but the recipient is, this could significantly change the effective ‘tax’ rate and any potential saving – of course, loans are not really tax, but they are collectible either through PAYE or through self-assessment (or potentially both) and will feel quite similar when the bill falls due.
- Pension contributions are generally much more tax-efficient where the payer is liable at higher rates, and again have the potential to significantly change the potential saving of transferring income. In other words, it may be less of a disadvantage to keep dividend income where it is, if the spouse/civil partner in question is getting higher rate tax relief on pension contributions as a result.
- It is not that unusual for retirees enjoying relatively significant investment income also to make substantial charitable donations under gift aid. The mechanism basically requires HMRC to transfer tax paid by the donor to the charity, which is good for the charity because it ‘boosts’ the size of the donation it ultimately receives by a quarter. But if HMRC finds that the donor has not already paid enough income tax (e.g. because his or her dividend income stream has been transferred to the spouse), HMRC will issue a tax charge against the donor so that HMRC gets back the tax that it has paid over to the charity.
- Even if the first spouse/civil partner is paying tax at the 38.1% additional rate, if transferring dividend income to the other spouse/civil partner puts that spouse/civil partner above the £100,000 adjusted income threshold so that they start to lose their tax-free personal allowance as well, the overall tax charge on the couple will almost certainly rise as a result.
So can I just transfer the income?
No! The settlements regime (at ITTOIA 2005 s 624 et seq) will act to treat that dividend income as still ‘belonging to’ the original owner, unless the first spouse/civil partner complies with the special exception for outright gifts of income-producing assets – in this context, the underlying shares themselves between spouses and civil partners, the key conditions being:
The gift includes rights to all the income arising from those assets (there can be no restrictions in place);
The asset transferred cannot be merely a right to income itself – it has to be something more.
The classic case on this is commonly referred to as ‘Arctic Systems’ (Jones v Garnett [2007] UKHL 35), which involved an IT contractor who transferred a percentage of the ordinary shares in the company, of which he was the main earner, to his wife. HMRC tried to argue that the gift was a settlement and that the income should be treated for tax purposes as still belonging to the husband; the House of Lords agreed that it was a settlement but that it, in turn, enjoyed the exclusion for outright gifts to spouses, etc., because Mrs Garnett:
- Received all the dividends due on those shares, and
- Those shares had voting rights and rights to the company’s capital on a winding-up of the company, so couldn’t be considered just a right to income
It is important to note that the shares in Arctic Systems were ordinary shares; the earlier case of Young v Pearce; Young v Scrutton [1996] STC 743 had gone badly for the taxpayers primarily because the spouses’ shares had limited non-income rights, so were considered to have comprised wholly or substantively a right only to income when transferred to the spouses. Taxpayers should be particularly careful with share classes that have had their non-income rights restricted.
Capital gains tax considerations
Transfers of assets between spouses and civil partners who are living together are generally treated as capital gain tax (CGT)-free, on the basis that they are deemed to carry across on a ‘no gain/no loss basis’; this basically means that both parties are deemed to have transferred at the donor spouse’s base cost.
Stamp taxes
Stamp taxes would not normally apply because no valuable consideration will be given.
While the CGT exemption for transferring assets between spouses doesn’t ‘care’ whether any actual consideration changes hands between spouses, the settlements exclusion for transfers between spouses applies only to outright gifts.
Conclusion
As a general rule, the aim will be to gift the underlying shares to generate dividend income in the hands of the recipient, so that both spouses enjoy similar income levels overall (and not necessarily the same amount of dividend income each).
As stated above, while balancing incomes between the two people in a couple would generally be considered quite fundamental and obvious tax planning, it is advisable to calculate the precise tax charge of any proposed adjustments, to ensure that the couple is genuinely better off; likewise, how tolerant and adaptable any new arrangements can be if income or other circumstances fluctuate from one year to the next.
While asset transfers between spouses are generally free of CGT, the inheritance tax (IHT) and estate planning implications of any significant capital wealth transfers may also be relevant, particularly where there are children or other non-spouse potential beneficiaries from previous marriages to consider, also where there is a risk that, unlike the donor, the recipient may have difficulty in building up eligibility for (say) entrepreneurs’ relief for CGT purposes or business property relief for IHT purposes.
