HMRC can use the settlements legislation in ITTOIA 2005 to tax dividends or profits received by one spouse as the income of the other, where the arrangement involves bounty and the giver keeps an interest. An outright gift of ordinary shares that carry real capital rights is protected by the exception in section 626, which the House of Lords confirmed in the Arctic Systems case (Jones v Garnett) in 2007. Shares that are wholly or substantially a right to income, dividend waivers and conditional gifts remain exposed.

Why does the settlements legislation reach spouses at all?

Section 620 of the Income Tax (Trading and Other Income) Act 2005 defines a settlement as including any disposition, trust, covenant, agreement, arrangement or transfer of assets. Section 624 then treats income arising under a settlement as the settlor’s income where the settlor has retained an interest. HMRC’s manual at TSEM4200 explains that a settlor has retained an interest if the property or income may be applied for the benefit of the settlor or their spouse or civil partner. A transfer of income producing property to your spouse therefore starts inside section 624.

The courts have narrowed the definition: there must be an element of bounty, meaning value provided without a corresponding return (TSEM4110, citing CIR v Plummer). A purely commercial transaction at arm’s length is outside. TSEM4200 summarises that the arrangement must be bounteous, not commercial, not at arm’s length, or, for gifts between spouses, wholly or substantially a right to income. HMRC states at TSEM4015 that the purpose is to stop an individual diverting income to someone who pays tax at a lower rate.

The legislation is aimed at spouses, civil partners and minor children. TSEM4220 and TSEM4320 say it does not apply where the recipient is another individual unless there are arrangements for the income to come back to the settlor or their spouse. Unmarried partners are therefore generally outside section 624, while gifts to minor children fall under the separate parental settlements rule.

What happened in the Arctic Systems case?

Garnett v Jones, reported as [2007] UKHL 35 and 78 TC 597, is the leading case. Mr Jones was an IT consultant who bought a newly incorporated company. He kept one of the two issued shares and gave the other to his wife. He was sole director and did the consultancy work; she was company secretary and did administrative work of around four or five hours a week. The company paid both of them small salaries and large dividends.

HMRC argued that the dividends paid to Mrs Jones were out of proportion to her contribution and were a settlement, taxable on Mr Jones under what was then section 660A of the Income and Corporation Taxes Act 1988 and is now section 624 of ITTOIA 2005. The House of Lords decided two things:

  1. There was a settlement. The arrangement would not have been made between parties at arm’s length and contained enough bounty. HMRC’s manual at TSEM4105 notes that in Jones v Garnett the bounty came from the expectation of the settlor’s future behaviour, his willingness to work for a modest salary.
  2. The outright gift exception applied. The share was an outright gift between spouses and was not wholly or substantially a right to income, so the charge did not bite and Mr Jones won.

Lord Hope observed that using a private company to route income to a spouse is likely to be a settlement, but the exception still applies so long as the shares from which the income arises are ordinary shares. It does not apply to shares whose rights are restricted wholly or substantially to a right to income.

How does the outright gift exception in section 626 work?

Section 626 disapplies section 624 for an outright gift of income producing property from one spouse or civil partner to the other if two conditions are met:

  • Condition A: the gift carries a right to the whole of the income.
  • Condition B: the property is not wholly or substantially a right to income.

Section 626(4) adds that a gift is not outright if it is subject to conditions, or if the property or related property is or may become payable to or applicable for the benefit of the giver. HMRC’s examples at TSEM4205 show the line. A let property given outright to a spouse produces rent that is the spouse’s income; the same gift subject to an agreement that the property can be required back is not outright, and the rent stays taxable on the giver. An IT consultant who gives all the ordinary shares in his one man company to his wife is protected: the shares carry capital rights, so the exception applies even though the profits come from his work.

When does HMRC still apply the settlements rules to couples?

  • Income only shares. In Young v Pearce and Young v Scrutton (1996), directors created B shares with no votes and no rights to assets on a winding up and issued them to their wives. The dividends were taxed on the husbands (TSEM4205). ACCA’s case summary contrasts this with Mrs Jones’s voting ordinary share.
  • Dividend waivers. If one spouse waives a dividend so that a larger dividend can be paid to the other, no property has been given, so the outright gift exception cannot apply. In TSEM4225, a wife with 80 shares waives, the company pays £1,000 per share on her husband’s 20, and £16,000 of his £20,000 is attributed to her. See dividend waivers.
  • Selective dividends on equal classes. Voting a dividend on one spouse’s B shares and not on the other’s equally ranking A shares is treated the same way (TSEM4225).
  • Special subscriber shares. TSEM4210 describes a share carrying rights only to the consultant’s earnings and repayment at par, issued to his wife for £1. That is caught because the property is wholly or substantially a right to income.
  • Partnerships. In TSEM4215, an architect brings in a non working spouse with half the income profits but no share of capital profits. That share is taxed back on him. An unlimited share in partnership capital and income would be protected.

ACCA also reports Patmore v HMRC (First tier Tribunal, 2010), where the tribunal found the husband held 48% of the shares on a constructive trust for his wife and taxed dividends above her entitlement on him.

Is subscribing for shares at formation treated differently from a gift?

The question HMRC asks, at TSEM4320, is whether the same payments would be made to someone who acquired shares at arm’s length. If both spouses put in capital and work, there is no bounty. TSEM4355 gives the example of a couple who each subscribed for half the shares and both worked full time in the business: the settlements legislation did not apply. It also gives the example of a manufacturing company owner who gave half his ordinary shares to his wife: there was bounty, but the shares had real capital value, so the gift was protected. As Arctic Systems shows, once there is bounty the result turns on the type of share given.

A worked example

Illustration only. A consultant owns all the ordinary shares in his company. His wife has no other income and the company has £20,000 of profit to distribute.

  • Option 1: he gives her half his ordinary shares outright, with full voting, dividend and capital rights, and no side agreement. Following Arctic Systems and TSEM4205, the dividends on her shares are her income.
  • Option 2: the company issues her a new class of non voting shares with no rights to capital, and votes dividends only on that class. The shares are wholly or substantially a right to income, section 626 does not apply, and the dividends are taxed as his income under section 624.

If income is attributed, it is taxed as if it had arisen to the settlor directly, at his marginal rates (TSEM4573). For 2026 to 2027 the dividend ordinary rate is 10.75% and the upper rate 35.75%, so moving a dividend back from a basic rate spouse to a higher rate spouse adds 25 percentage points of tax on the amount within those bands, before the dividend allowance.

What should couples check before sharing a company?

  • Give or issue ordinary shares with full rights to votes, dividends and capital, recorded properly through a stock transfer or share allotment and the register of members.
  • Do not attach conditions or understandings that the shares will come back.
  • Pay dividends in proportion to shareholdings unless there is a commercial reason, and treat waivers with caution, especially where reserves could not support the same rate on every share (TSEM4225).
  • Remember that section 623 gives the settlor the same deductions and reliefs he would have had if he had received the income (TSEM4017).
  • Check whether the managed service company rules apply first, as TSEM4210 notes that where they treat all payments as the worker’s earnings there is no need to consider the settlements legislation.

The settlements rules sit alongside the wider planning covered in salary versus dividends and how to pay dividends legally. Getting the share rights right at the start is far easier than defending an enquiry later.

If HMRC opens a check into your return, tax investigation insurance pays your accountant’s fees. Solar Protect cover pays up to £100,000 with no excess; it never pays tax, interest or penalties. Read how our cover works or get a quote.

Related Accountapedia entries

Sources

Reviewed by Christine Anderson, Broker, Solar Protect. Last reviewed 8 October 2026. Part of Accountapedia, the Solar Protect guide to UK tax and accounting. This page is general information, not personalised advice.