By: ilyas Patel February 13, 2024

Family Tax Planning:

A Guide to Income Splitting

In the complex world of family finance management, strategically organising wealth to maximise tax efficiency can substantially enhance household savings.

We discuss strategies of income distribution within families, highlighting how such practices, when properly planned, can optimise tax allowances for the entire family.

Through examination and referencing specific tax enquiry cases, we aim to shed light on HMRC’s perspective, and the critical considerations involved.

(Read Time: Approx. 5 minutes)

Topics Discussed:

Optimising family and tax planning and exploring Family Investment Companies (FICs) as a strategic planning tool.
Critical tax considerations such as Joint Property Rules and Settlement Anti-Avoidance Provisions.

Understanding Joint Property

Exploring Joint Property Rules

For spouses or civil partners holding assets together, the law typically divides income 50:50 for tax purposes, as outlined in s.836 ITA 2007.

However, through a formal declaration, it’s possible to have income assessed based on actual beneficial interests, potentially unlocking tax advantages linked to property income.

A Closer Look

The Settlement Provisions (s.619-s.626 ITTOIA 2005 and s.660A+ ICTA 1988) serve as a deterrent against shifting income within families to evade taxes.

These rules ensure that any redirected income retains its tax obligations, except in cases of outright gifts between spouses or civil partners.

Nevertheless, this shield does not extend to income-focused gifts, highlighting the thin line between tax planning and avoidance.

A Cautionary Example – AJ Bingham v HMRC [2013] TC02528

Mr. Bingham, a solicitor, embarked on a family tax planning exercise with the intention of sharing joint bank account interest, aiming to utilise each family member’s personal allowances and lower tax bands effectively.

However, this approach attracted HMRC’s attention, leading to a significant and unexpected application of the Settlements anti-avoidance rules.

Initial Strategy and HMRC Investigation:

Mr. Bingham opened joint bank deposit accounts in the names of himself, his wife, and his children (upon reaching majority).
Each family member was a signatory on the accounts, with Mr. Bingham controlling the chequebooks. Despite this, the children had access and used the accounts on occasions.
The interest earned was initially split equally for tax purposes. However, Mr. Bingham later adjusted the apportioned sums to maximise the use of personal allowances and lower tax bands for each account holder, varying year by year.

HMRC’s Challenge:

Upon reviewing Mr. Bingham’s Self-Assessment return, HMRC assessed all the interest income against Mr. Bingham alone, arguing that he had created a settlor interested trust.
Discovery assessments were raised for 14 years, accompanied by 30% penalties, based on the premise that Mr. Bingham had not effectively transferred beneficial interest in the funds to the other family members.

The First Tier Tribunal (FTT) Decision:

The FTT concluded that Mr. Bingham, having deposited all the funds, was the settlor of a settlement and retained control over the accounts, indicating no beneficial interest transfer to other family members.
The tribunal also addressed the issue of discovery assessments, finding no negligence or fraud on Mr. Bingham’s part. The tax matters were deemed technical, and HMRC’s joint income guidance was criticised for its lack of clarity, leading to the setting aside of penalties, leaving assessments for five years.

Considerations and Outcomes:

The FTT stressed the importance of fairness, requesting HMRC to account for tax already assessed on some family members to prevent double taxation.
This case underscores the significance of clear documentation and the potential risks of retaining control over assets intended for income splitting within families.

Key Tax Considerations

Capital Allowances: Ordinary property letting businesses cannot claim capital allowances for dwelling houses, with exceptions made for Furnished Holiday Lettings and certain other scenarios.

Special Reliefs: Property income benefits from specific reliefs, such as Rent-a-Room Relief and Replacement of Domestic Items Relief, with different rules applying to Furnished Holiday Lettings.

Making Tax Digital (MTD): From April 2026, landlords with rental income above £50,000 will need to comply with MTD for Income Tax, extending to those with over £30,000 from April 2027.

Insights and Strategies

The Bingham case vividly illustrates the depth of consideration required when planning income distribution among family members. The absence of clear documentation and the perceived control over the distributed assets by the settlor were critical factors in the tribunal’s decision.

It highlights the necessity for airtight planning and the potential benefits of individual accounts or explicit declarations of trust to unequivocally establish the intended beneficial ownership of assets.

We’ve gathered some detailed strategies and insights to navigate income splitting effectively, drawing from the lessons learned:

Establish Clear Documentation

Declaration of Trust – A formal declaration can unequivocally establish the beneficial ownership of assets, ensuring that HMRC recognises the intended distribution of income among family members.
Separate Accounts – Setting up individual accounts for each beneficiary can simplify the allocation process, making it transparent and straightforward for tax purposes.

Understand and Utilise Legal Frameworks

Joint Property Rules – Familiarise yourself with s.836 ITA 2007, ensuring that income from jointly held property is allocated based on actual beneficial interests, not just split 50:50 by default.
Settlement Provisions – Be aware of the anti-avoidance rules (s.619-s.626 ITTOIA 2005 and s.660A+ ICTA 1988) that can apply when transferring assets within the family, particularly to minors or spouses without an outright gift.

Mitigate Risks of Retaining Control

Transfer of Control – Ensure that when assets are distributed, the control over those assets also transfers. This means not just giving away the income but also the power to decide how those assets are used.
Consult Experts – Engage with tax professionals to navigate the complexities of tax legislation, ensuring that your income splitting strategy aligns with current laws and HMRC guidelines.

Maximise Tax Planning

Utilise Allowances and Bands – Align the distribution of income with the personal allowances and lower tax bands of each family member, adjusting year by year as circumstances change.
Family Investment Companies (FIC) – Consider establishing a FIC as an alternative to direct income splitting, allowing for a structured approach to manage and distribute family wealth while optimizing tax efficiency.

Prepare for HMRC Scrutiny

Evidence of Beneficial Ownership – Keep comprehensive records demonstrating that beneficiaries have true beneficial ownership and control over their assets.
Anticipate and Respond to Investigations – Have a strategy in place for responding to HMRC inquiries, including retaining expert tax advice to defend the chosen income splitting approach.

Concluding Thoughts

Cleverly orchestrating the allocation of family income can significantly enhance your tax planning strategy.

It opens doors to substantial tax savings while necessitating a thorough understanding of legal and procedural nuances.

The complexities highlighted by the Bingham case underscore the importance of expert advice.

To ensure compliance and optimise your fiscal benefits, it’s imperative to consult with seasoned tax professionals.

Reach out to the specialists at www.taxexpert.co.uk and secure your peace of mind. Contact us today for bespoke advice and to navigate the tax landscape with confidence.

Kind regards,

Ilyas Patel

Call us today: 01772 788200