Income-shifting dividend waivers

Following a recent First-tier Tribunal (Tax Chamber) decision, owner-managed businesses may need to review arrangements for shifting income from higher rate taxpaying shareholders to their lower rate taxpaying spouses if those arrangements involve dividend waivers.

The tribunal held that dividend waivers made in favour of shareholders’ wives were settlements and did not fall within the outright gifts to spouse exception.

Taxation of Dividends

Dividends paid by UK companies are subject to income tax, regardless of whether the dividend is revenue or capital.

UK resident taxpayers liable to income tax at the basic rate are taxed on the dividend at the rate of 10%.

UK resident taxpayers liable to income tax at the higher rate are taxed at the rate of 32.5% on the dividend.

Settlements Legislation

Settlements legislation is intended to prevent an individual (settlor) from gaining a tax advantage by making arrangements that divert his income to another person who is liable to tax at a lower rate or is not liable to tax.  Where the settlements legislation applies to a dividend waiver, all of the income waived is treated as that of the settlor.

There is an exemption for outright gifts to spouses, but the exemption only applies if both of the following apply:

• The gift carries the right to the whole of the income arising from the property.
• The property is not wholly or substantially a right to income.

Dividend Waivers and Anti-avoidance

A dividend waiver may constitute income shifting, to which the settlements legislation may apply. HMRC takes the view that the settlements legislation is likely to apply to dividend waivers if any of the following applies:

• The level of retained profits, including the retained profits of subsidiary companies, is insufficient to allow the same rate of dividend to be paid on all issued share capital.
• Although there are sufficient retained profits to pay the same rate of dividend per share for the year in question, there has been a succession of waivers over several years and, where the total dividends payable in the absence of the waivers exceed accumulated realised profits.
• There is any other evidence that suggests that the same rate would not have been paid on all of the issued shares in the absence of the waiver.
• The non-waiving shareholders are persons whom the waiving shareholder can reasonably be regarded as wishing to benefit by the waiver (for example, a spouse or other family members).
• The non-waiving shareholders would pay less tax on the dividend than the waiving shareholder.

Most typically, the legislation applies to husband and wife companies where one spouse (a higher rate taxpayer) waives a dividend and the other spouse (not a higher rate taxpayer) receives a substantial dividend as a result.