Lee Sharpe looks at the special income tax rules for married couples and civil partners.
Married couples and civil partnerships are deliberately provided with a set of measures that are supposed to make things easier from an income tax perspective. However, many taxpayers do not fully understand how the legislation works. This article will attempt to break this down into a few simple steps.
The legislation is at ITA 2007, ss 836, 837.
The legislation applies automatically to split income equally…
Where the couple are married or in a civil partnership and are living together as a couple, the legislation applies automatically to split income from jointly-held assets arising on a 50:50 basis, regardless of the actual split in ownership.
Example 1: Transfer of an interest in a rental property
Thelma and Louise are in a civil partnership. Thelma transfers a 25% stake in her buy-to-let (BTL) rental property to Louise, such that they now own the property 75:25 (3:1) in Thelma’s favour.
From that point onwards, the legislation automatically splits the income equally (50:50) between them, for tax purposes. How the profits are actually divided is completely irrelevant at this stage.
…except when it does not…
There are a few scenarios where the income is not automatically split equally, according to that same legislation, including:
- where there is a ‘genuine’ partnership (as distinct from a simple joint investment);
- where the property qualifies as the commercial letting of furnished holiday accommodation; and
- where neither spouse, etc. is beneficially entitled to any income at all from the property.
Depending on the particular circumstances where those exceptions apply, then the division of income is likely to follow the actual beneficial ownership by default (although partners in a partnership may decide to split their incomes differently, as and when they see fit, as can joint investors who are not married or in a civil partnership).
…or if the couple notifies HMRC
This is the Form 17 route, which requires a joint declaration of the actual underlying beneficial interest in the property (assets) to be submitted to HMRC.
I have in the past heard that taxpayers have been told that they must submit Form 17 within 60 days of a change in underlying beneficial ownership, or the notice is invalid. This is misleading. HMRC will accept that a Form 17 joint declaration is effective if notification is effected within 60 days of the date of the election. But the split in ownership could be years old.
Example 2: Declaration on Form 17
Some years later, Louise gets a higher-paid job and all her share of the joint BTL property income is now being taxed at 40%, while Thelma has unused 20% basic rate band.
A simple solution would be for Thelma and Louise to submit a Form 17 to HMRC, declaring that Louise should be taxed on only the 25% stake that she beneficially owns; Thelma would be taxed on more income as a result, but at her lower marginal tax rate, and the couple would be better off overall.
Key points on Form 17
HMRC now asks for documentary evidence to prove that the underlying beneficial ownership is as declared. Other important points to note include:
- If it takes more than 60 days from signing to be submitted, it will be rejected.
- This does not mean that the documentary evidence must be less than 60 days old; the transfer could have been effected years ago. Nor does it mean that the documentary evidence needs to be ‘re-done’ if the paperwork takes too long to get to HMRC.
- If the Form 17 is rejected because it is out of date, a fresh form may be submitted, with the same backing evidence, but preferably with a shorter interval between signing and posting.
- Since Form 17 is used to ‘break’ the tax law assumption that income is shared equally between married couples etc. then the form is useless if income actually is split 50:50, such as:
o where ownership is split equally anyway; and/oro where the property is owned beneficially as joint tenants because in such cases, the ownership and income must be split 50:50.
- Form 17 therefore works only where property is owned as tenants in common (which permits an unequal division of ownership and income therefrom).
- Form 17 declarations are ‘sticky’ (see below).
‘Sticky’ forms and how to deal with them
Once a declaration has been made, it applies indefinitely; a couple cannot submit a Form 17 in 2018/19 to get their jointly-held property income taxed 3:1 and then decide in 2021/22 to ‘waive’ the form so that they revert to being taxed equally. Nor can they submit a fresh Form 17 to revert to sharing their income 50:50 for tax purposes; Forms 17 declaring equal beneficial interests are legally ineffective.
Assuming that death, divorce or permanent separation are not preferred options, the only way to ‘break’ the current Form 17 split is to change the underlying beneficial ownership again, which will reset the arrangement back to a default 50:50 split of income.
Between couples who are married or in a civil partnership, transferring ownership (only a token amount is necessary) should be relatively painless, in terms of capital gains tax (although one should beware the stamp duty land tax implications of transferring ownership of an interest in a property that is subject to a mortgage).
There is no need to notify HMRC that the previously-submitted Form 17 is redundant. The legislation to revert back to sharing income equally applies automatically. It might, however, be useful to write to HMRC to advise of the change, although documentary evidence of the change in underlying beneficial ownership would still need to be kept.
Once the underlying beneficial ownership has changed, the legislation assumes that income is again split equally, until a fresh Form 17 is submitted, reflecting the new share in beneficial ownership and, therefore, income. Of course, that replacement Form 17 could be signed and submitted immediately that there was a change in the underlying ownership, so that the income split changed immediately (say) from 3:1 to 5:4, with no intervening period of 50:50.
Conclusion
The Form 17 regime is useful but might appear a little quirky. There is nevertheless a logic in the underpinning legislation, and there is helpful guidance in HMRC’s Trust and Estates manual at TSEM9805–TSEM9878. A simple declaration of trust may be all that is required to evidence the underlying beneficial interest in a property, or by implication that such ownership has changed.
But I should point out that, over the years, I have come across more than one landlord who was quite blasé about declarations of trust, thinking that they were relevant only to Forms 17 and had no other implications. Now, I’d be the first to admit I am no lawyer, but they really, really do.
