Keith M Gordon MA(Oxon) FCA CTA(Fellow)

The House of Lords has unanimously dismissed HMRC's appeal in the Arctic Systems case (Jones v Garnett (HM Inspector of Taxes)).

 

The decision of the Court of Appeal therefore stands.

 

Each of their Lordships gave a detailed explanation of their reasons.  For a copy of the full judgment, click here.

 

Keith Gordon will be lecturing on the Arctic Systems decision around the country.  Click here for a list of dates and venues.

 

In summary

 

Their Lordships held that the arrangement entered into by Mr and Mrs Jones constituted a statutory settlement within the meaning of section 660G of the Income and Corporation Taxes Act 1988. Thus Mr Jones was prima facie within the provisions of section 660A(1).

 

However, their Lordships held that the let-out for outright gifts between spouses/civil partners was available to them (section 660A(6)).

 

Consequently, Mrs Jones (and not Mr Jones) was assessable on the dividends she received from the family company even though most of the profit was as a result of Mr Jones's efforts for the company.

 

Lord Hoffmann

 

His Lordship adopted a broad definition of the types of transaction that could amount to settlements for the purposes of the legislation (now found in ITTOIA 2005, Pt. 5, Ch. 5).  He found support for doing so in the case of Crossland v Hawkins [1961] Ch 537.

 

Lord Hoffmann held that the arrangements entered into between Mr and Mrs Jones did not constitute "a normal commercial transaction between two adults".  It was, instead, an arrangement that would have been "highly abnormal" had Mr and Mrs Jones been dealing with each other at arm's length.  In his Lordship's opinion, Mr Jones provided a benefit to Mrs Jones and this constituted the necessary element of bounty.

 

However, turning to the let-out in section 660A(6), Lord Hoffmann held that any element of bounty triggering the provisions of section 660A(1) meant that there was "an outright gift" for the purposes of section 660A(6).  Therefore, given that the ordinary share carried considerably more rights than a mere right to income (cf the preference share in Young v Pearce [1996] 70 TC 331), the exception applied.

 

Lord Hope of Craighead

 

Lord Hope agreed that Mr Jones provided bounty to his wife.  His speech therefore focused on the let-out provisions in section 660A(6).  His Lordship analysed rights of an ordinary share.

 

He held:

 

"But so long as the shares from which that income arises are ordinary shares, and not shares carrying contractual rights which are restricted wholly or substantially to a right to income, the settlement will fall within the exception created by section 660A(6)."

 

Later, his Lordship commented:

 

"Property given which consists of ordinary shares in a company will always attract the exception in section 660A(6)."

 

His Lordship added that it made no difference that the company had no assets when Mrs Jones acquired her share.  What mattered was the rights attaching to the asset comprised in the settlement (i.e. the share), not their state at any particular point in time.

 

Lord Walker of Gestingthorpe

 

Lord Walker's speech provided a historical perspective on the meaning of settlement.  He added that a statutory settlement can exist even when tax avoidance is not intended.  However, where it is intended to avoid tax, that intention is a relevant factor when determining whether or not there is a statutory settlement. His Lordship implied that where tax is not saved by the arrangement, there can be no statutory settlement.  This speech will be well worth studying in detail.

 

With respect to identifying the arrangement, Lord Walker held that Mr Jones's act of bounty was allowing Mrs Jones to acquire half of the business entity for the nominal sum of £1.  That, according to his Lordship, amounted to an outright gift of the share and therefore allowed the let-out provisions in section 660A(6) to apply.

 

His Lordship had difficulty with the test in section 660A(6) that the property given should not be "wholly or substantially a right to income".  However, he was reassured that there was always the possibility that the company would build up undistributed reserves and therefore the ordinary share satisfied the conditions of section 660A(6).

 

Baroness Hale of Richmond

 

Lady Hale's speech provides a useful summary of the taxation of wives over the past 200 years leading up to the introduction of independent taxation in 1990.

 

Unlike her colleagues, her Ladyship expressed doubts as to whether the establishment of a family company and the allocation of shares between spouses could even constitute a settlement.  She was particularly bothered by HMRC's approach to challenge only some cases where spouses made different financial contributions to the enterprise (i.e. in cases where it was always intended that this should be the case).

 

Lady Hale had a lot of sympathy for the approach taken by the Chancellor, Sir Andrew Morritt, in the Court of Appeal.  However, given the views of the other Law Lords (and the fact that they were unanimous on the overall outcome), Lady Hale said it would be presumptuous to reach a different conclusion the settlement point.

 

Lord Neuberger of Abbotsbury

 

Lord Neuberger considered the question of whether or not there was a settlement to be one of principle and one adequately covered by authority.  In particular, his Lordship cited the cases of Payne (1940) 23 TC 610, Hawkins and Butler v Wildin (1988) 61 TC 666.

 

His Lordship was not bothered by the fact that the bounty primarily arose from an expectation of what might happen after the share was acquired.

 

In the course of the oral argument, it appeared that it was Lord Neuberger who had greatest concern about the applicability of section 660A(6) in this case.  His speech explains why.  His Lordship explains that he had a lot of sympathy with the approach taken by Park J (in the High Court) that the arrangement as a whole comprised more than an outright gift and thus fell outside the terms of section 660A(6).  However, his Lordship held that the difficulty goes away if one does not detach the bounty from the property given.  Because they are so interdependent his Lordship held that the arrangement did in fact constitute an outright gift.

 

The bounty test

 

In 1980, the House of Lords ruled that the settlements legislation applied only in cases where the taxpayer had bestowed 'bounty' on another person (IRC v Plummer [1980] AC 896). 

 

Previously, it had been thought by many that the correct test was whether or not the parties had entered into a commercial transaction.

 

Although warnings were soon given about using the term 'bounty' as the basis for the test (see, for example, Lord Roskill in Chinn v Hochstrasser [1981] AC 533 at 535), the label has stuck.

 

In Jones v Garnett, the use of the term 'bounty' was generally criticised.

 

In particular, Lord Hoffmann described it as "old fashioned" and suggested it "[conjured] up the image of Lady Bountiful in The Beaux' Strategem".  He also thought it an unfortunate term when applied to the provision for an individual's spouse or minor children.

 

Lady Hale expressed her displeasure with the term 'bounty', which she found both patronising and inaccurate.  Her speech uses the term 'gratuitous'.