Monday, November 12, 2012

What is the settlements legislation?

Sharing dividend income from a limited company with a non-fee-earner has been a classic tax avoidance tactic employed by consultants, contractors and locum doctors who operate through limited companies. It is useful as it allows the use a non-fee-earner’s tax allowances and progressive taxation rates in order to save significant tax.

However, unless the non-fee-earner is a spouse or civil partner qualifying for a spousal exemption, HMRC could treat all the company’s fee income as that earned by the contractor, and tax them accordingly. The settlements legislation will apply if a contractor gives shares in their contractor limited company to a partner, family member or friend who does not work in the business yet receives an income.

In most cases, the settlements legislation won’t apply to a spouse or civil partner living with the contractor. This was confirmed by the Arctic Systems case in which HMRC tried to prove that IT contractor Geoff Jones, the fee-earning spouse in a husband-and-wife-owned limited company, had made a ‘bounteous settlement’ of shares in his company on his wife and lost. It provides now some level of certainty that in cases when a contractor gifts ordinary shares with full voting and capital distribution rights to a cohabiting spouse or civil partner who plays an active shareholder’s role, the settlements legislation (S624 ITTOIA 2005) won't apply.

However, in all other cases, the settlements legislation would considers the gift of shares from a fee-earning contractor to a non-fee-earner, such as a partner, family member or friend, as a ‘bounteous settlement’. In such cases any income arising from that settlement should continue to be taxed as if it were the fee-earning contractor’s. And what is worse is that HMRC can backdate its assessments, so that if a contractor and their partner had been operating in this fashion for six years, then the last six year’s worth of the non-earning partner’s income would be added to the contractor’s for those years. The resulting back taxes would then have interest and penalties added.

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