UK Fact-File Part 2:
Individual Business Domestic Taxation

2.5 UK Husband and Wife Partnerships

Special rules governing husband and wife partnerships or companies

Where a husband and wife run a small business together, it is sensible to use the maximum personal tax allowance for both spouses.

Until April, 2008 a husband and wife running their own family business could divide income in whatever proportions they chose, including the issue of dividends.

However, following the landmark Arctic Systems case in which a couple won a legal battle against HMRC (on appeal in the House of Lords), which had claimed thousands of pounds in back taxes due to the manner in which the couple had divided their income and dividends between them, HMRC now takes a much tougher stance on this issue.

The following is an extract from updated guidelines on the HMRC website as a result of this case:

‘Mr Y, an architect, commences business as a sole trader. The business is successful and a few years later annual profits are in the region of GBP80,000. The business is transferred to a new partnership of Mr & Mrs Y. A deed is executed under which income profits are to be shared equally but the rights to share in capital profits belong solely to Mr Y. Mrs Y subscribes no new capital and carries out no work whatsoever for the partnership, that is to say she is a sleeping partner. Profits for the year are GBP80,000 and GBP40,000 belongs to Mrs Y. This is a bounteous arrangement transferring income from one spouse to another. The Settlements legislation will apply and Mrs Y’s share of the profits will continue to be assessed on Mr Y’.

So it can be seen that it might be difficult to convince HMRC that the profit split is equitable in terms of input to the business unless involvement by both spouses in a business is fully documented.