In certain circumstances you may be able to minimise your income tax by pushing a portion of profits to a spouse by making them a company shareholder.
Dividends are paid to Shareholders – not Directors
Dividends are paid to shareholders. Normally in proportion to the shares held. So if you own 50% of a company, you are entitled to 50% of the dividends.
As basic rate taxpayers (ie those in 20% income tax rate) do not pay income tax on dividends this creates an opportunity to make a spouse a shareholder and send them a portion of your dividends to make full use of their basic tax rate band. As long as they are not already higher rate tax payers.
In the 2016/17 income tax year we recommend that owner/managers pay themselves £8,040 in salary and £34,960 in dividends. At this level only basic rate income tax is paid.
If your spouse does not have any earnings then the same applies to them, they can earn a salary of £8,040 plus dividends of £34,960 before any higher rate tax is due. So rather than paying yourself dividends of £60,000 you could make it so that you each receive dividends of £30,000 and then no one would have to pay any higher rate tax.
If the spouse does already earn an income but it’s less than £40,000 per year then it might still be worthwhile but the tax free dividends available will be smaller and you would have to take an alphabet share approach (see below).
Bear in mind that directors and shareholders are absolutely distinct. You can be a director but not a shareholder and you can be a shareholder but not a director. It is only shareholders that can receive dividends. Directors can only receive a salary.
How to transfer shares
If your company is made up of 100 x 1p ‘ordinary’ shares then all the main shareholder has to do is to transfer 50 of those shares from themselves to their spouse. Your Caprica Accountant can sort out the paperwork required for this for you.
However, as you would expect HMRC are do have rules in place to stop flagrant abuse.
The most notable of these is that you are not able to transfer shares at less than ‘market value’.
For a brand new company this is easy. The market value of the company is £0 so a transfer for a nominal value (eg: £1) is absolutely fine.
If the company has been trading for a while and has built up assets (whether that’s cash in the bank, customers owing money or stock held) then you can’t argue the company is worth £0 and here we would need to make an assessment of the company’s value and work out whether it is still worthwhile to make a transfer. It may not be because of stamp duty and capital gains tax implications.
In the above example we assumed that dividends would be paid as a fixed proportion of shareholdings but if you adopt alphabet shares you can actually pay one amount to one shareholder and a completely different amount to a different shareholder. Alphabet shares get rid of this fixed proportion concept allowing you to pay different dividends to different classes of shareholder.
Alphabet shares refers to different share classes eg. Class A shares, Class B shares, Class C shares etc.
So to achieve a better outcome in the example above we would convert the 100 x 1p ordinary shares to 50 x 1p Class A shares and 50 x 1p Class B shares. From that point you can transfer all the Class B shares to the spouse.
Now we can make it so that the Class A shareholder receives £28,600 in dividends in a tax year and the Class B shareholder receives £21,400 of dividends. You can see how this gives us much more flexibility to ensure that all parties receive the most tax efficient level of dividends for their circumstances.
Get advice on this issue tailored to your situation
In this post we have explained the general rules but it’s always important for an accountant to fully understand the level of income of each party and the value of the company to ensure any transfer won’t fall foul of HMRC rules.
If you are a Caprica client and have a spouse earning a small or no income then get in touch with your Caprica Accountant who will be happy to advise you on the optimal share structure for your company.