IR35 Case 6 - Husband and Wife companies
Key lessons from this case
- Where spouses set up a limited company, equally sharing the equity, but one of the spouses effectively does all the fee-earning work, the IR can demonstrate that this income is solely that of the fee earner
- Even if the non fee earner completes a considerable amount of administrative work for the business, their share of equity is considered a settlement given by the other fee-earning spouse
- The dividends paid to the non fee earning spouse are treated by the IR as if they were earnings of the fee earning spouse, with additional tax and National Insurance liabilities
- That the fee-earning spouse did not take a market-based wage from the business in its early stages influenced the decision that the shares were a settlement.
Summary of the case
Background
Geoffrey Jones provided IT consultancy services for end clients via agencies who insisted he create a limited company if they were to give him work. Mr Jones created Arctic Systems Ltd, and on advice from his accountants that it would be more tax efficient, allocated the shares equally between himself and his wife, Mrs Jones. Mr Jones completed the fee-earning work and Mrs Jones managed all the administrative work, including being company secretary.
Why did the Inland Revenue act?
The IR took the view that Mr Jones should pay tax on his earnings, including the dividends paid to Mrs Jones, because they felt the dividends to his wife were earnings that arose from a settlement by Mr Jones; ie Mr Jones "gave" the shares to his wife.
Why did the contractors appeal?
Mr Jones appealed the assessments, saying that the shares allocated to his wife and the resulting dividends were not a settlement. In addition, Mr Jones also claimed that the IR had acted unreasonably when handling some of his assessments.
Who won and why?
The IR dropped three of the four assessments requiring Mr Jones to pay tax on his wife′s dividends just before the case was heard, for procedural reasons. The Special Commissioners reviewing this case said the fourth assessment should stand, but the IR did act unreasonably in handling the other three assessments.
The judgement was that the allocation of the shares to Mrs Jones was a settlement on her by Mr Jones. Income from those shares should therefore be treated for tax purposes as if they were Mr Jones′ earnings. Not all the Special Commissioners who were reviewing the case agreed on the issue of settlement, but the presiding commissioner had the casting vote.
In deciding that the allocation of shares was a settlement, the following reasons were given:
- The company was deliberately set up and shares allocated to maximise tax efficiency
- Mrs Jones, although responsible for administration, did not generate fee income
- The allocation of shares to Mrs Jones with the intention to declare dividends was "bounty", qualifying the share allocation as a possible settlement
- The dividends were income as a result of the settlement of the shares by Mr Jones to Mrs Jones.
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