Hope for the best and prepare for the worst – how a divorce can affect your business

Close-up of people communicating while sitting in circle and gesturing

By Nicola Harries, Partner, Nick Atkins, Partner, and Kathryn Saunders, PSL, Stevens & Bolton LLP.

 

As a shareholder or director of an SME business, it is easy to understand why you may involve your spouse in the business. Transferring a shareholding to them can be done without incurring Capital Gains Tax and allows dividends to be drawn tax effectively by both spouses.

 

Making your spouse a director or company secretary so that they can receive a salary and be auto-enrolled in a pension scheme makes perfect financial sense when all is going well. It is far from uncommon to see all of the directors’ spouses “on the books” so that funds can be withdrawn from the business and taxed as efficiently as possible for the benefit of the whole family.

 

If your spouse is genuinely involved with the running of the business, then of course their involvement makes perfect sense. In many cases however, the drive to extract funds from the company tax efficiently can, and very regularly does, return to haunt the owner(s) and businesses when a marriage comes to an end. If more than one spouse is “on the books”, the potential for disruption is amplified accordingly.

 

How can you minimise potential disruption following a divorce?

 

Think very carefully before transferring shares to your spouse, and seek advice about the potential ramifications in all eventualities.Family courts will distinguish between assets built up during a marriage, and those brought to a marriage by one party. The value of assets built up during a marriage will often be shared equally between spouses, particularly after a long marriage. If you owned your interest in the company before meeting or marrying your spouse, be very cautious about transferring shares to them. Doing so may substantially reduce your chances of successfully arguing that the value of the company referable to your combined shareholding is a ‘non-matrimonial’ asset. That means that the value of that shareholding is more likely to be shared if there is a later divorce.

 

If you do decide to transfer shares, protect yourself and the company as much as you can in case things go wrong. Review the articles of association first, and, if necessary, amend them to provide maximum protection. Check whether the articles include pre-emption provisions. Commonly, these would require a shareholder (including a spouse) to offer their shares to existing shareholders first, rather than third parties. Limiting an aggrieved spouse’s options with regards to the disposal of a shareholding is a good idea.

 

Articles of association often contain permitted transfer provisions to enable a shareholder to transfer some or all of their shares to their spouse (and often other close relations). Before making use of permitted transfers, ensure that the husband or wife to whom the spouse plans to transfer shares will be required to transfer them back if the marriage is dissolved. If your spouse’s shareholding is affected by such provisions, they will have less leverage in negotiations when the articles will automatically strip them of their shareholding at the end of a divorce. Both permitted transfer and pre-emption provisions could negatively affect the value of a spouse’s shareholding during a marriage breakdown, giving greater leverage to the SME-running spouse in negotiations.

 

Think very carefully about the employment angle.If your spouse receives a salary from the company, they will have potential claims against it in the event that their employment is terminated as a result of a divorce. Sacking a spouse could trigger an unfair dismissal claim, or worse a claim of discrimination. Not employing your spouse will avoid these potential complications. If however it is too late for that, make sure that you cover off all potential employment claims within any divorce settlement.  You would not want your spouse to reach a divorce settlement, only to find that they then sought a “second bite of the cherry” by making subsequent claims to an employment tribunal.

 

Think carefully about HMRC. Remember that after a divorce, the court will not approve a situation where an ex-spouse remains “on the books” as a cost-effective means of paying ongoing spousal maintenance. Even though it may have been the case during the marriage, without any genuine contribution by the ex-spouse to the company, the court considers such arrangements to be tantamount to tax evasion – HMRC may choose to investigate you or the company as a whole, and family judges have been known to report to HMRC in certain situations.  Continuing with your ex-spouse as an employee means that their potential employment claims will remain open for the duration. Also consider the complications that may be caused when trying to sell a company employing an ex-spouse.

 

Many SME owners justifiably put expenses through the company. Family lawyers regularly hear claims that a family’s lifestyle is funded through expenses put through the business, and that the profits declared, and the income actually drawn, are not reflective of the level of income that the company could create and maintain. The investigation of such claims is time-consuming and expensive, requiring a thorough analysis of the company’s finances by external forensic accountants.  Keeping a clear delineation between company and personal expenses will make such an investigation easier to address.

 

Lastly, whether your spouse has had a genuine role in the company or not, they are likely to be aware of information (potentially information that is commercially sensitive) that they have picked up during the course of the marriage. Ensure that the divorce settlement contains appropriate undertakings to prevent the dissemination of that information once the divorce has concluded.

 

It would be unrealistic to expect that all married SME owners would live married life planning for a potential divorce. For many, the urge to draw funds from a company as tax-efficiently as possible will continue to be the driving factor. However, taking advice and educating yourself as to the potential ‘bear traps’ that lurk unseen if a divorce does happen, could save you a lot of time, money and aggravation if the worst happens. A little knowledge can go a long way and being aware of the potential problems that may later emerge will give you the choice of guarding yourself, your company and your business partners against them.