In the last few days, HM Treasury have published a consultation on proposed legislation on how to stop a tax advantage being gained by individuals who are using incorporated and partnership structures as vehicle to provide work/services and then to subsequently  “shift income” from one individual to another in order to reduce their personal tax liabilities.  This publication titled “Income Shifting: a consultation on draft legislation” is the predicted response from the government following HMRC’s recent defeat in the Arctic Systems case at House of Lords, which confirmed that the spouse exemption in the settlements legislation was an acceptable piece of tax planning involving the shifting of income from the primary shareholder to a secondary shareholder.

Overview

The consultation document includes commentary about why HM Treasury wishes to introduce new legislation, draft legislation to identify and tax “shifted income”, plus examples of what is and what is not regarded as “shifted” income and how the affected individuals will need to complete their self assessment tax returns.  It is important to note that at this stage HMT are in a consultation process and this is not the final legislation.  Whilst at the end of the consultation period there is are unlikely to be significant changes to the proposed legislation, until such time as the legislation has been finalised, it is not possible to confirm the impact of the new legislation may have on individuals who currently use limited company and partnership structures, other than to say the it will be effective from 6 April 2008 onwards. 

The draft legislation is intended to capture any married couples (or civil partnerships) who share business profits, whether as company distributions por profits from partnerships, that have been created wholly or largely through the efforts of only one of the individuals in the partnership, if the following conditions are met:

• the individual who is “shifting” the income is party to the arrangements or has the power or control to influence those arrangements
• that individual forgoes/shifts income (directly or indirectly), as this is shifted to the other individual
• the individual doing the shifting has the power to control or influence the amount of income shifted
• the main or one of the main purposes for shifting the income is to reduce the tax liability in respect of the shifted income amount

If the legislation applies, then the individual who has shifted the income to another individual must include the amount shifted on their self assessment tax return.  However, all four conditions must be met if the new legislation is to apply, whilst there is also an exemption for “genuine commercial” arrangements, or arrangements which would have been entered into in dealing with unconnected parties on an arms length basis.

Effect on Secondary shareholders

For those married couples or civil partnerships currently using secondary shareholding arrangement to distribute income in the most tax efficient manner, they can continue using this arrangement as the new legislation does not take effect until 6 April 2008, i.e. the next tax year.  In respect of the 2008/09 tax year, whilst it would seem unlikely that the use of a secondary shareholding arrangement will be beneficial from a tax efficiency perspective, until the legislation has been finalised it is not possible to provide advice on any alternative tax planning opportunities, but once the legislation has been finalised PayStream will review and look to advise you on the suitable options based on personal circumstances.

Can a Secondary shareholder be introduced?

As noted above, subject to meeting the necessary condition, the use of secondary shareholder arrangements during the 2007/08 tax year are an allowable method of tax planning available to married couples and civil partnerships. Therefore, if you wish to consider introducing a secondary shareholder in order to mitigate your personal tax liability, we would be happy to talk to you and based on your personal circumstances we will be able to identify and suitable proposals. Please call us on 0800 027 2340 if you would like to talk through how best to structure your affairs in the light of the recent consultation document.

Summary

The consultation is an unwelcome piece of news for small and family businesses, as this seems to further increase the legislative and tax burden on an already complex entrepreneurial services market.  PayStream will continue to monitor and review communications from HMT and HMRC on this topic, to ensure all our customers are made aware of the potential impact of these proposed changes as soon as possible to enable any appropriate action to be taken.