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Section 660a Background
With Section 660a the HM Revenue and Customs tried to challenge freelance contractors who ran their own Limited Company Consultancies and chose to split company profits with their spouse, where the spouse received profits arising from fee generating work done by the contractor.Splitting income in this way provided a tax advantage to contractors as income that would normally be taxed in the contractors higher rate band was being split to a spouse who either paid no or minimal tax on the sum.
Section 660a Legislation
Section 660a, is part of the settlement legislation which has existed since the 1920s. Traditionally it was used by the HM Revenue and Customs in matters of settlement of trusts. ‘Settlements’ occur where a person gives another a right to income but not to underlying capital.In 1995 Section 660 was updated when the Income Tax and Corporation Taxes Act 1988 (ICTA 1988) was altered with the addition of Sections 660a to 660g.
Not until 2003 did the HM Revenue and Customs begin to take an aggressive stance with Section 660a. They used S660a to look at the distribution of profits in family companies specifically where family members were receiving company profits but were not generating revenue for the company.
The HM Revenue and Customs took the view that this type of income division was ‘artificial’ as it diverted income from a higher rate taxpayer to a lower rate tax payer in order to avoid taxes. Thus they attempted to use Section 660a to prevent a tax advantage being gained from these settlements i.e. the gift of limited company shares from one person to another to minimise tax on dividend income.
The Spouses Exemption
There is a specific exemption for spouses within Section 660a. The Section does not apply where there is an outright gift of property (i.e. Shares) from one spouse to another. However, this exemption only applies if the gift is not ‘wholly or substantially a right to income’, i.e. there must be an underlying capital value to the gift.The HM Revenue and Customs argued that, in some cases, shares in a family business may be considered solely a right to income. The UK’s professional accounting bodies however argued that the HM Revenue and Customs interpretation was wrong, especially where spouses were involved.
Factors the HM Revenue and Customs looked for
When the HMRC were accessing Limited Companies against Section 660a they looked at a number of factors, including:- The main fee earner drawing a low salary leading to greater profits from which dividends were paid to shareholder (Including family members)
- Disproportionately large returns on capital investments
- Differing classes of shares enabling dividends to be paid only to shareholders paying lower rates of tax
- Dividends being waived so that higher dividends could be paid to shareholders paying lower rates of tax
- Income being transferred from the fee earner to a friend or family member who paid tax at a lower rate
The ‘test case’ for the new HMRC aggressive stance on Section 660a was the ‘Arctic Systems’ case. After all appeals had been exhausted, the courts found against HMRC and in favour of the proprietors of Arctic systems. Unfortunately, rather than accept the court’s ruling on the law, HMRC promptly announced that they would change the law. New legislation is planned, and may be in the April 2008 budget, that will target Income Shifting. It may be the case that some of these factors resurface in the new legislation
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