Tax Legislation - S660A Settlements Legislation
S660A Settlements Legislation - What is it?
S660A, or the settlements legislation as it is also known, has been on the statute book since the 1930s but has been little used by HMRC against husband and wife companies ... until recently that is!
The intention of the legislation is to prevent you entering into an arrangement whereby income is passed to another in order to reduce your overall tax liabilities. Most commonly the legislation will apply where an individual seeks to divert income to members of their family or friends.
The settlements legislation can only apply where there is an "element of bounty" - in other words, the person making the arrangement must have some intent to confer a benefit on another person. Otherwise, normal commercial transactions, e.g. a sale of shares at market value, could fall within the settlements legislation.
Who could it affect?
The legislation could potentially affect thousands of family based companies where shares have been distributed in a disproportionate basis to their involvement in the company. A successful challenge can result in a considerable amount of back taxes and interest becoming payable covering the last six years.
HMRC has recently been given a fresh impetus to challenge these arrangements with their High Court victory against Arctic Systems Limited. The taxpayer, an information technology specialist, and his wife each owned one share in a company which earned profits by providing the taxpayer's personal services to clients. He drew a very small salary so that the company earned profits which were then distributed as dividends. His wife, the company secretary, received half of these dividends. The appeal went in favour of HMRC viewing the company structure as an "arrangement" which fell within the settlement provisions and that the taxpayer was the settlor, resulting in the need for the dividends paid to his wife to be treated as his income for tax purposes.
Prior to this appeal, accountancy professionals frequently advised the allocation of shares to a spouse or partner of the main income earner in order to be more tax efficient. However, the Arctic Systems case now sets clear guidelines that in doing this HMRC would require the main income earner to pay tax on any company profit before allocating it to a spouse or partner who does not wholly contribute to the company income generation. Freelance World therefore does not recommend share allocation to non-contributing spouses, partners, friends or relatives.
Factors that HMRC may take into account:-
- The main earner drawing a low salary leading to enhanced profits from which dividends can be paid to shareholders who are friends or family members. HMRC will look to the market value attributable to the contract and whether the fact that the contractor draws a smaller salary and as such increases the profit which can be distributed as dividends. If he or she does it will be seen as a bounteous act. For example, where an individual received £70,000 from a contract, withdrew £10,000 as salary and the remainder of the profit was split equally as a dividend between the individual and his wife.
- Dividends being waived so that higher dividends can be paid to shareholders paying lower rates of tax.
- Income being transferred from the person making most of the profits of a business to a friend or family member who pays tax at a lower rate.
What happens if I am caught by S660A?
HMRC will class any dividend payment to the spouse as income of the main fee earner and therefore tax it as such. HMRC can go back 20 years if neglect can be shown. In this instance, neglect does not have to be more than having knowledge of the legislation and not doing anything to change the current company set up. HMRC have stated that they will not impose penalties for previous years, however, they will for current years. They will of course still ask for additional tax for previous years.
What precautions can be taken?
The main and most obvious way of avoiding any risk under this legislation is for the main income earner in the company to hold a 100% shareholding in the company.
However, at this early stage it is yet to be determined whether the company can be structured and set up in a way which would avoid risk under this legislation. It is likely that in the next few years we will see principles emerge through case law as has been the instance with the IR35 regulations.
Insurance to protect against the risks of investigation under the settlements legislation is now available from varying bodies. These insurances can offer professional representation in any HMRC enquiry, legal costs involved with an investigation and may even offer a level of indemnity against any sums demanded by the HMRC.