Your accountant has suggested you follow the tried and test method of reducing tax on profits by sharing ownership of your business with your spouse. That’s fair enough, but an added tactic can increase the tax savings. What is it?

Splitting profits

Whether you run your business as a sole trader or through a company, there are ways to split profits with a spouse or civil partner to reduce the tax payable. This is possible where your other half doesn’t have enough income to pay tax or is liable to income tax at a lower rate than you. The best time to arrange profit splitting is when the business is new or young, but that’s not always possible or might not be effective if your partner pays tax at the same rate as you.

Timing doesn’t always matter

If your business is already established when you decide to split profits it’s still tax efficient, in fact there’s potentially an extra and often overlooked tax break. If you’re a sole trader you can form a partnership by transferring a share of the business to your spouse or partner. The principle is similar for companies; you can transfer some of your shares (they must be ordinary shares) to your spouse or partner. Profits from the business can then be shared which can reduce the tax bill on profits.

Example. Barney started his company, Acom Ltd, from scratch seven years ago. It’s done well and is now worth £800,000. Acom pays Barney a salary of £12,000 plus £85,000 per year in dividends, of which almost £50,000 is taxed at the higher income tax rate. Sonia, Barney’s civil partner, has annual income of around £2,000. Transferring 45% of the business to her so she receives a proportionate share of the income virtually eliminates the higher tax rates Barney pays on dividends thereby saving thousands in tax.

Power Tip. An extra tax break can be engineered if you pay interest on borrowing which doesn’t qualify for tax relief. For example, a loan to buy or improve your home. If that’s the case, sell the share of your business to your spouse or partner instead of giving it to them.

Example. Barney and Sonia have a £180,000 mortgage on their home and the interest they pay on the loan is around £10,000 per year. There’s no tax relief on interest paid on loans used to buy your home but there is for loans to buy a share of a business. This includes buying ordinary shares in a company that runs a business. There are of course conditions to relief for loan interest.

Barney sells 45% of his shares in Acom to Sonia for £90,000. Sonia borrows at a similar interest rate to their mortgage (extending the loan with the mortgage lender should be possible but not vital to the plan) to pay Barney for the shares. He uses the money from Sonia to repay £90,000 of the mortgage on their home.

The outcome of the borrowing and repayments is that Barney and Sonia have swapped £90,000 of their home mortgage for £90,000 used to buy a share of Acom. The interest on Sonia’s new loan qualifies for tax relief whereas the interest on the mortgage it replaced did not. As a result, in addition to the tax savings made by splitting income from Acom they save around another £1,000 each year in tax relief on loan interest.

The tax break is achieved by replacing borrowing for which there’s no tax relief for interest, e.g. a home mortgage, with a loan for which interest qualifies for relief. This involves selling a share of the business to your spouse or partner who borrows to fund the purchase. You use the payment received to pay down the non-qualifying loan.

This article has been reproduced by kind permission of Indicator – FL Memo Ltd. For details of their tax-saving products please visit www.indicator-flm.co.uk or call 01233 653500.