Where one spouse earns everything and the other earns little, the household wastes a personal allowance and an entire basic-rate band while the earner pays higher-rate tax on income that could have been taxed at a lower rate elsewhere. Moving income within a family is one of the oldest planning ideas there is. It is also one of the most frequently done badly, and HMRC has specific legislation aimed squarely at it.
Route one: employing your spouse
The simplest approach is to put a spouse on the payroll for work they genuinely do, bookkeeping, admin, client contact, marketing, company secretarial duties. The salary is deductible for the company and taxed on them, using their personal allowance and basic-rate band.
Two conditions decide whether this survives a challenge:
- The work must be real. HMRC will ask what was done. A job description, a record of hours and evidence of output matter far more than the amount.
- The rate must be commercial. A deduction is only available for expenditure incurred wholly and exclusively for the trade. Paying £40,000 for a few hours of light admin fails that test, and the excess is disallowed. Pay what you would pay someone else to do the same job.
Practical points: pay it through the payroll like any other employee, keep the level above the National Insurance lower earnings limit if you want the year to count towards their state pension record, and be aware that if there is a genuine contract of employment, National Minimum Wage rules can apply. Family members are not automatically outside the NMW regime.
Route two: alphabet shares
The other approach is to give a spouse shares so they receive dividends directly. Alphabet shares, separate classes (A ordinary, B ordinary and so on) carrying broadly equivalent rights, let the company declare different dividends on different classes, so the split can be varied year to year as circumstances change.
This is efficient because dividends carry no National Insurance, and each shareholder has their own £500 dividend allowance and their own basic-rate band. With dividend rates having risen to 10.75% ordinary and 35.75% upper from April 2026, keeping income inside a second person's lower band is worth more than it used to be.
The settlements legislation, and why Arctic Systems matters
This is where careless arrangements come apart. The settlements legislation allows HMRC to tax income back on the person who effectively provided it, where income has been diverted to someone else without a genuine transfer of value. Applied to a company, that means dividends paid to a spouse being taxed on the working shareholder anyway.
The saving grace is the exemption for outright gifts between spouses, which applies where the gift is a genuine outright transfer of property carrying substantial rights, not merely a right to income. In the well-known Jones v Garnett case (universally called Arctic Systems), the House of Lords held that an outright gift of ordinary shares between spouses fell within that exemption, even though the practical effect was to shift dividend income.
What that decision does not do is bless every arrangement. The exemption depends on the shares being ordinary shares with real rights, and on the gift being outright:
- Shares carrying only a right to dividends, with no meaningful voting rights and no entitlement to capital on a winding up, look very much like a right to income and risk falling outside the exemption.
- Shares subject to strings, an obligation to hand them back, or an arrangement where the transferor keeps effective control, are not outright gifts.
- The exemption is for spouses and civil partners. Gifts to adult children, siblings or unmarried partners do not benefit from it, and are considerably more exposed.
Dividend waivers: the arrangement to avoid
A common shortcut is for the main shareholder to waive their dividend so more flows to the other shareholder. HMRC attacks waivers vigorously, particularly where there were not enough distributable profits to pay the same rate to everyone had the waiver not been made, which is precisely the situation waivers are used to engineer. Where that is the case, HMRC will typically treat the arrangement as a settlement and tax the income on the waiving shareholder. If different amounts need to go to different people, use separate share classes, not waivers.
Doing it properly
- Issue proper share classes carrying full rights, voting, capital and dividend, not income-only shares.
- Make gifts outright and document them, with stock transfer forms, board minutes and updated registers.
- Check distributable reserves before every dividend and minute the declaration properly. An improperly declared dividend is not a dividend, it is a director's loan.
- Keep employment genuine and paid at a commercial rate.
- Think about the exit. Shareholdings affect Business Asset Disposal Relief, and a spouse who qualifies in their own right has their own £1 million lifetime limit, so structure with the eventual sale in mind, not just this year's tax.
Legitimate, but not casual
Family tax planning is entirely proper. What fails is the version done without documentation, with income-only share classes, or with waivers used to move money that the profits could not otherwise support. The structure and the paperwork are what carry it. We set up and review family shareholding structures, share classes and remuneration through our tax planning service, alongside the director's salary and wider extraction decisions. If your arrangement grew up informally over the years, have it reviewed before HMRC does it for you.