How much tax saving if I make my spouse a shareholder?

A still-common question when setting up a limited company is ‘How much tax can I save from making my spouse a shareholder?’ and understandably so, writes Helen Christopher, a chartered accountant who specialises in the contractor sector.

For better or worse...

Let’s start with the positives.

Frequently, the primary motivation for adding a spouse as a shareholder is to optimise tax outcomes, particularly in relation to dividend income.

Dividends, which are distributed company profits, are paid to shareholders in proportion to their ownership of shares and are subject to income tax. By adding a spouse as a shareholder, it provides scope to strategically manage tax liabilities and allowances across both spouses with the potential to result on significant tax savings.

Making your spouse a shareholder: example

Let’s look at an example.

John owned 100% of the shares in ABC Ltd and drew a salary of £12,570 and dividends of £65,000 (in tax year 2023/24)

John’s tax liability for the year is

Salary                                              12,570

Dividends                                        65,000

Total Income                                   77,570

Personal Allowance                        (12,570)

Dividend Allowance                        (1,000)

Taxable Dividend Income                64,000

Basic rate dividends 8.75%             5.600

Higher rate dividends 33.75%         8,876

Total Tax Liability                          £14,476

Introducing your spouse to the limited company shareholding

If John passes 25% of his shareholding to Jane, his dividends will decrease to £48,750 and Jane’s share would be £16,250. We will assume Jane has no other income for the purposes of this illustration. In this scenario their combined tax liabilities would be £9,226, saving £5,250.

John’s tax liability for the year is now

Salary                                              12,570

Dividends                                         48,750

Total Income                                    61,320

Personal Allowance                         (12,570)

Dividend Allowance                         (1,000)

Taxable Dividend Income                47,750

Basic rate dividends 8.75%            5.600

Higher rate dividends 33.75%        3,392

Total Tax Liability                         £8,992

And Jane’s tax liability for the year is:

Dividend Income                               16,250

Personal Allowance                           (12,570)

Dividend Allowance                           (1,000)

Taxable Dividend Income 2,680

Basic rate dividends 8.75%              234

Total Tax Liability                          £234

There may be even further opportunities to optimise tax savings by paying a ‘market rate’ salary for a spouse’s involvement in the business to utilise their tax-free allowance if they genuinely undertake a role within the business.

Potential HMRC issues when making a spouse a shareholder

Including a spouse as a shareholder is subject to a piece of legislation known as the Settlements legislation.

This legislation is designed to prevent income-shifting, where one party deliberately redirects personal income to another individual with a lower tax rate than themselves.

You might then ask, how has John (in our example) lawfully passed his shares to Jane to reduce their tax liabilities?

What is the spousal exemption when making a spouse a shareholder?

The technique described in John and Jane’s situation has been used successfully by many couples thanks to a “spousal exemption.” In a landmark case, known as the Arctic Systems case, HMRC contended that the wife’s dividends should be taxed on the husband at a higher rate since the shareholding had been shifted just to avoid higher rate tax. In the case, the husband and wife owned the shares 50/50.

The court ruled in favour of the taxpayers, citing the spousal exemption. For the exemption to be met, certain conditions must exist:

• Part of the beneficial ownership of the company must be genuinely passed over from one spouse to another.
• Shares should confer full voting rights, rights to dividends, and proceeds on any ultimate sale.
• They must be able to do what they wish with any dividend income or sale proceeds, and there should be no prior arrangement to pass funds back to the original owner.
• Shares should be an outright gift.
• The couple must be co-habiting.

HMRC have shown little appetite over the years to attack the spousal exemption, despite plenty of rumours that they might! If they were to raise the question, the best defence is to ensure that both individual shareholders are actively involved in the business and decision-making.

Capital gains tax, married, and unmarried

One of the conditions of the spousal exemption is that the shares should be gifted outright to the other party. Where assets are gifted and transferred, Capital Gains Tax (CGT) must be considered.

For a married couple or civil partnership, it is relatively easy to pass shares in an existing company to a spouse or partner, as the transfer is exempt from CGT.

For unmarried couples, the position is less straightforward, as a transfer of shares in an existing company will generally be treated as if the ‘transferor’ had sold the shares at market value for CGT purposes. In this case, the couple can jointly elect to claim ‘holdover relief.’ In this scenario the shares are effectively treated as if they had been transferred for a price equal to the original purchase cost. Hence, the transfer can be made without giving rise to any CGT liability. And CGT liability will only occur when the shares are ultimately sold to a third party.

Note that ‘holdover relief’ is generally only available where the company is carrying on a qualifying business – usually a trade or furnished holiday letting.

Final thought

So, structured correctly and being mindful of the need for genuine involvement in the company, passing shares to a spouse can be a very tax-efficient and can have a significant impact on household income.