The rules for sharing income from your company with your spouse or civil partner are well known. But, if you’re not legally joined, is there a tax-efficient way to share your income? Helen Johnstone looks at this in more detail below.
A few years ago, HMRC lost a long running fight to prevent married couples/civil partners from sharing a company’s income to reduce their joint tax bill. Despite threats from HMRC that it would ask the government to change the law to prevent such tax saving measures in future, nothing further has happened. That’s good news for couples who are married but is no help to those who are not. While it’s still possible for unmarried couples to save tax by income sharing it can come with other tax costs.
If an individual gives their unmarried partner shares in their company, it can trigger a capital gains tax (CGT) bill. This would not be the case if it were a gift or transfer between married partners.
Janet and John have been a couple for ten years during which time Janet set up a successful company. Her income from the company puts her in the higher rate tax bracket. John is a part-time worker whose income never exceeds £10,000 per year and is therefore not liable to income tax. Janet could shift some of her income by transferring ordinary shares in her company to John and paying dividends on them. For CGT purposes the transfer is treated as if Janet has sold the shares to John at market value. As the value of the shares has risen since Janet paid for them the increase in value is a taxable gain. However, the transfer might still be worth making.
Janet could give away enough of her shares each year so that the resulting capital gain would be less than her annual exemption (£12,300 for 2022/23). This would allow income sharing.
If the transfer of shares by Janet resulted in a gain greater than her annual CGT exemption, if the conditions were met business asset disposal relief (BADR) would apply. That would mean the tax rate on gains would be just 10%. This tax might be worth paying if the income tax saving from sharing the company’s income was greater in the long term.
Janet owns 100 shares in her company. In March 2023 each share is worth £10,000. Janet transfers ten to John in March 2023 and another ten in late April 2023. This results in a capital gain of just under £100,000 each transfer. After taking account of Janet’s CGT annual exemptions for 2022/23 and 2023/24 she is left with a gain of just under £87,700 for each year. The tax at the BADR rate means Janet owes £17,540 (£87,700 x 2 years x 10%). John now owns 20% of the ordinary shares in the company. It pays him dividends of £30,000 per year. He’ll owe tax on this of just £2,450 (£2,000 at 0% plus £28,000 at 8.75%) compared to £11,805 (£30,000 x 39.35%). This means that after just two years Janet and John have saved £18,710 income tax. That’s already greater than the CGT cost of the share transfer.
If your company’s business is growing, and therefore its value along with it, the earlier you transfer shares to your unmarried partner the better. This means the share value and corresponding CGT bill will be lower than if the transfer is delayed.
If your partner is in a lower tax bracket than you it is possible to save income tax by transferring some shares in your company so that they can receive dividends that would otherwise be payable to you. There can be a capital gains tax cost of making the transfer but it’s worthwhile if the income tax saving is greater in the long run.