From 6 April 2008 it will be far more difficult to reduce your tax bill by paying dividends or profit shares to less active shareholders in your company or members of your partnership. This is because of a new law on income shifting that will affect nearly every partnership and jointly owned company in the UK. It doesn't matter whether those co-owners (partners or shareholders) are married, other relatives or simply friends.

If you make a bigger contribution to the business than your co-owners, but receive a similar share of the profits, the Taxman could argue that you have shifted income away from yourself, so it falls into the hands of those co-owners who play a less active role in the business. You will have to pay tax on the amount of shifted income, and the less active co-owner(s) will be treated as having never received that shifted income.

Although the new income shifting law will only affect dividends or profits shares paid out from 6 April 2008, those profits may have been earned by the business many years earlier. If you are planning to pay a dividend on 6 April 2008, to place that income in the 2008/09 tax year, you may want to bring the payment forward to avoid the new income shifting rules. However, you should be careful of pushing your total income for 2007/08 into the higher tax bracket.

If you want to continue to pay profit shares or dividends to less active co-owners of your business from 6 April 2008, you will need to justify the amount paid according to the recipient's contribution to the business. This contribution could be measured by:

• the amount and type of work done
• the individual's responsibility for making key decisions for the business
• the capital contributed to the business
• the business risk taken on, such as a personal guarantee of a business loan

You may need to adjust the agreed profit sharing ratio of your partnership, or the number of shares each individual holds in your company, to reflect the actual input of each individual. We can help advise you on the best action to take and what to do in order to reduce the risk of being attacked for income shifting.

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