Interesting tax consequences of a 50:50 Split
November 2006 Tax Newsletter
References in this article to husband and wife, also apply to partners subject to the Civil Partnership Act.
Inheritance Tax - Shares in Private Limited Company
The following two paragraphs provide an interesting example where the taxable value of a gift of shares may be less than the market value!
Consider a small trading company that has been valued at £1m. There are two shareholders Mr X and Mr Y who both own 50% of the issued share capital. Common sense would indicate that their individual shareholdings are worth £500,000. Whilst this would be the case should they actually sell the business, different rules would apply if they considered gifting their shares.
Inheritance tax looks to the value lost by the person making the gift, not the value gained by the person receiving the gift. If Mr X gifted his shares to his son, he would be transferring a minority interest. (51% is needed to exert control.) For valuation purposes a minority interest may be subject to a discount of between 20% to 30% of the market value. So a gift could be made worth £500,000 and be treated by the Revenue as valued at say £400,000 for inheritance tax purposes.
Income Tax - Property ownership and rental income
Should a property be owned by more than one person it is normal practice to agree the percentage share owned when the property is bought.
If our Mr X and Mr Y also jointly owned a rental property it would suggest that not only would they split the profit or loss on sale of the property equally, but would also share rental income arising from the ownership in the same proportion.
However the Revenue will accept a split of rental income at variance with the ownership of the property as long as all parties agree. So Mr X could be allocated 90% of the rental income and Mr Y 10%. This is a useful strategy to consider but it does not apply to a husband and wife who own a rental property.
In husband and wife situations it may be sensible for one party to receive the bulk of the rental income and pay tax at lower rates - thus creating an overall increase in post tax income for the family. But to gain the Revenue's approval the couple must own the property as tenants in common, and the percentage owned by each party has to be the same as the division of rental profits. So if Mr A and Mrs A own a rental property as tenants in common, 90% owned by Mrs A and 10% by Mr A, rental income and profits can only be split 90:10.
Income Tax - Husband and wife owned businesses
If a husband and wife team run a small limited company, or trading partnership, and each own 50% of the shares or rights to share of profits, they need to be mindful of the "settlements legislation" particularly where there are few assets in the business.
If Mr X owns 50% of the business but does 90% of the work in the business, the Revenue can use existing legislation to restore a commercial balance to the situation. In this example the Revenue could argue that as Mr X does 90% of the work then he should receive 90% of the dividends/share of profits distributed by the business.
This area of tax law is currently being tested by the Arctic Systems case, a House of Lords decision is pending. But as current legislation could be applied, shares of business income between husband and wife need to reflect the underlying commercial reality. A 50:50 split on paper does not prevent a challenge by the Revenue that other divisions should be applied.
