Paying a spouse: what PSCs can and can’t do

With PSC contractors feeling under the cosh from both the removal of the NI Employment Allowance for sole-director ‘Ltds’ and the dividends tax, it’s little wonder that a growing number are asking five big questions about getting their company’s money into personal hands by paying a spouse or partner, writes Matt Fryer, head of compliance at Brookson.

1. Can I pay my spouse dividends in my personal service company?

• Your spouse can benefit from dividends paid to them if they are a shareholder of their spouse’s company. Ideally as a husband-and-wife company, the couple acts as one unit sharing the risks and rewards of ownership. This will be the case even though the spouse does not perform a significant level of work for the business.
• The shares issued to the spouse should be an ordinary share representing the full bundle of rights i.e. the right to dividends, voting rights and the rights to assets of the company on winding up.
• It is possible to vary dividends to provide scope for efficient tax planning by affording the spouse an A share (or alphabet share). But using dividend waivers to vary dividends should be avoided at all costs.
• The crucial point to remember is that all other rights to the share are preserved and that when you issue or transfer a share, it is an outright gift from you. This approach is necessary following the Arctic Systems case -- so in order to follow this precedent then you do need to consider the following:

- You both need to be married (or in a civil partnership) at the point the shares are issued

- The spouse has full and actual access to the dividends paid to them (payment into their own bank account or at least a joint bank account is recommended)

- Of course, dividend vouchers should be provided to support the payment.

2. What’s happened since the Arctic Systems case?

Essentially the government has maintained that potential income splitting cases will be kept “under review”. The specific Settlements legislation (S660A) relevant to the Arctic Systems Limited case has been raised by HMRC with regards to other cases- (Patmore v HMRC 2014) for example, where HMRC eventually lost the case.

The conditions of the case were quite specific and not really relevant to contractors as such, but one of the issues raised concerned the application of the settlements legislation where Mrs Patmore received dividends where she had restricted voting rights.

Potentially the income-splitting issue could come back on the agenda -- but it would be difficult to gauge how this could be established from a practical perspective.

3. Can I pay dividends if I’m not married, or in a civil partnership with my partner?

Potentially unmarried couples living together in a similar arrangement to husband and wife are at risk of not meeting the previous precedent set by the Arctic Systems case, but the settlement legislation by which HMRC brought this case is broad enough so that it encompasses unmarried individuals. It is important in this respect, that dividends are paid to the partner’s separate bank account for avoidance of doubt. Also, establishing their commercial involvement in the company will mitigate any perceived risk to the unmarried status with both individuals equally involved in the business.

4. Can my spouse/partner be remunerated through the company in other ways?

i. Director fee

A spouse (or indeed anybody who genuinely acts as a director) can be remunerated as a director of the company and be paid a director’s fee if they are an office-holder of the company. They can also be reimbursed tax-free expenses reasonably incurred in the performance of their role as a director.

As an active director they can be paid a salary (if not employed elsewhere or has no other income) that utilises their personal allowance -- this will be tax free.

Remember though that a director manages the company, and there are duties and responsibilities of the role that the director needs to be aware of.

ii. Salary

As a bona fide employee, a spouse (or indeed anybody who genuinely acts as an employee) can be paid a salary based on the provisions of their contract of employment. Therefore, the practical aspects of their contribution to the company need to be evidenced. The salary that the spouse receives must be commensurate to the work performed and must be wholly and exclusively related to the business.

In addition, the salary will need to be processed through the payroll RTI system in order for corporation tax relief to be granted. Reimbursement of tax free expenses will also be available so long as it can be evidenced that the cost was incurred wholly, exclusively and necessarily in the performance of duties.

iii. Expenses

Shareholders (and the company) are not entitled to tax relief on reimbursement of expenses made to shareholders. This is because they only act in the capacity as shareholder -- this is a passive role with the only income generated being the payment of dividends. Contrast this with an employee (or director), who incurs expenses wholly, exclusively and necessarily in the performance of their duties for the company; these can be fully reimbursed by the company and in most cases, will be tax free.

5. What about IR35 implications?

If you are captured under IR35, then you are limited to the availability of profits in your company from which you can pay a spouse’s /partner’s dividends or a salary, as all of the income from your contract is taxed as employment income (apart from the 5% expenses allowance).

In these circumstances, you do need to monitor the availability of profits from which you can pay your spouse’s dividend or salary, or you could find that your company becomes loss-making.

If there are retained profits from earlier periods, or you work on a mixture of contracts inside and outside IR35, then there is still scope to pay dividend or salary.

Final thought

Husband and wife/partner companies still remain a valid tax planning tool for small businesses. But big obstacles remain too. So contractors should seek advice from a specialist accountant before putting in place any of the outlined strategies and arrangements.