Section 660a, often intertwined with IR35 investigations, is another controversial piece of legislation designed by HMRC to prevent tax avoidance, particularly in contracting and small businesses.
Arguably as subjective to determine as IR35, it’s almost as unpopular and is often used as a segue for HMRC to investigate deeper into a contractor’s tax arrangements.
What is Section 660a?
Introduced back in the 1930s as a part of trusts legislation, Section 660a was an almost dormant piece of legislation that HMRC revived to counter a perceived growing threat; the illegitimate splitting of income between two people to avoid paying higher-bracket income tax. This is usually practiced by contractors who are directors of their own company, and is called ‘settling’.
The application of Section 660a attempts to tax the full dividend income that the single contractor has earned as opposed to treating it like two separate incomes after a portion is gifted to another party, usually a family member, who pays tax at a lower marginal rate than the individual themselves. A common example of this is the gifting of shares in the contractors personal service company.
The Settlements Legislation is a piece of tax legislation which is now contained within Chapter 5, Part 5 of Income Tax (Trading and Other Income) Act 2005. It’s still most commonly referred to as Section 660a (or S660a) though.
Who can be caught by Section 660a?
S660a doesn’t apply to all contractors who are splitting their income – there are some perfectly legal circumstances that allow it. For example, a contractor whose spouse or partner brings in 50% of income for the company to the shares they receive would be above board. Similarly, a company where both partners have purchased their shares instead of one party being gifted them is also unlikely to come under fire from HMRC.
It’s worth bearing in mind that even gifts of shares between spouses/civil partners should not be penalised. S660a allows outright gifts of assets (i.e. company shares) provided the gift:
- is unconditional;
- carries a right to the whole of the income; and
- is not substantially a right to income.
This means that you risk being caught by Section 660a unless you’re paying a portion of your dividend income to your spouse exclusively (children, siblings or parents are not compliant) who has either bought or been gifted a 50% share for market value, and can be proved to bring in 50% of your company’s income.
How can I avoid being caught by S660a?
Whilst there is no bullet-proof way avoid being caught by S660a, aside from only having a single person in the company own 100% of the shares, the following should go some way to defending yourself should you catch HMRC’s eye.
Stick to one share type
Avoid having different types or classes of shares. If your company issues what are known as ‘alphabet shares’ - i.e. ‘A’ and ‘B’ shares - that have different rights attached to each, you could find yourself on the wrong side of S660a. Make sure you use only ordinary shared to stay compliant.
Earn your share
Each party that receives a dividend should contribute to the company’s income an equal portion of what they earn. In other words, any returns a shareholder receives should be proportionate to the work they do – if not, HMRC will question it.
Don’t pass on your share
Avoid passing up or waiving dividends without sound commercial reasons that would stand up in a hearing. If HMRC catch wind that one of the shareholders is waiving dividends so the second shareholder can receive more in the way of payment (and thus use more of their lower rate allowance), it will be viewed as suspicious.
Keep shares equal
Try to ensure that all dividends are paid at the same rate. For example, if the higher rate tax payer is taking £0.50 per share, but the lower rate tax payer is taking £1.00 per share (so that more of the lower rate tax payer’s tax band is used), HMRC will see this arrangement as blatant tax avoidance.
Kids not allowed
Don’t use anyone under the age of 18 as a shareholder to avoid paying higher rate taxes. Aside from exceptional cases, there’s no way that HMRC would ever consider a child as a fee earner – a definite red flag.
What happens if I get caught by S660a?
The fall-out from being caught by Section 660a differs from case to case. Broadly speaking, HMRC would treat the diverted dividend income, in full, as your own and tax it at higher rates. This would amount to an effective tax rate of 25% on the dividends, where the individual is a higher rate payer. In addition, interest is charged on tax paid late at the rate of 3%.
HMRC can backdate charges for up to 6 years of ‘late’ tax, which would amount to a substantial bill if you are caught by the legislation.
Whilst S660a is not so commonly used now in comparison to previous years, it still lurks in the background so as to cause some concern for contractors. If you have any doubts as to your S660a risk whatsoever, we strongly suggest seeking professional advice.