Jones v Garnett: the High Court Decision in a nutshell

Much commentary on the Arctic Systems case has concerned questions such as: "Why does the tax system discriminate against families?", "Is legislation that in some circumstances taxes one spouse based on the income of the other compatible with the principle of independent taxation of husbands and wives?", "Is it fair for the Revenue to target husband and wife companies if, as has been reported, the DTI has for some time been encouraging husband and wife companies to make the very arrangements which the Revenue now affects to find objectionable?".

Important though those wider questions may be, this article concentrates instead on the narrower issue of what legal questions the High Court decided in the Jones v Garnett case and the reasons for the court's decision.

Background: what is a settlement?

Tax legislation covering "settlements" has existed since 1922. Put simply a "settlement" is an arrangement made by one taxpayer ("the settlor") under which another taxpayer (usually though not necessarily a relation of the settlor) receives income which he or she has not fully earned and which is therefore a "bounty".

A settlement nearly always involves the settlor providing funds, directly or indirectly for the settlement.

The effect is that in many cases tax is saved because, for example, the recipient of the "bounty", because of his or her lower total income, might be taxed at the standard rate of income tax rather than at the higher rate which would be suffered by the settlor if the settlor had not reduced his own income by means of the settlement.

The settlements legislation, which is now found in s.660A of the Income and Corporation Taxes Act 1988, seeks, in the case of families, to neutralise this tax advantage by providing that the income arising under the settlement is treated for tax purposes as if it was still income of the settlor if the settlor or the settlor's spouse has an interest in the property generating the income. Thus, generally speaking, it is possible to reduce overall tax liability by a settlement in favour of someone else unless that someone else is your spouse (or under-age child).

There is, however, an exception to the general definition of a settlement stated above. S.660A(6) provides that an outright gift from one spouse to another of property from which income arises, is not a settlement providing (paraphrasing the legislation very loosely) the property is not merely (or mainly) a right to income and providing the spouse receiving the gift receives the right to all of the income from the property (and not merely part of the income). This exception was introduced at the same time as independent taxation of husbands and wives.

The questions decided by the High Court in the Jones v Garnett case

The legal issues which fell to be decided by the High Court in the Jones v Garnett case were:

  • Was the arrangement made by Mr Jones in respect of the company Arctic Systems Ltd, a settlement under the general definition of a settlement?
  • If so, was it nevertheless saved from being a settlement by s.660A(6)?
  • Was the arrangement made by Mr Jones in respect of the company Arctic Systems Ltd, a settlement under the general definition of a settlement?

The court decided that it was. The rationale was essentially as follows. Mrs Jones worked for the company and was paid "adequate remuneration" for what she did. She did not invest in the business (other than paying £1 for her 50% shareholding).

Mr Jones worked for the company for a salary "far below his true earning power" and this resulted in a profit, part of which was distributed to Mrs Jones as a dividend.

The dividend which Mrs Jones received was therefore a "bounty" over and above the adequate remuneration she received for her work, that bounty being funded indirectly by Mr Jones. And the dividend income arose from property (the £1 share) in which Mrs Jones, the spouse of Mr Jones, had an interest (i.e. she was the owner of the share). Hence there was a settlement.

  • Was the arrangement saved from being a settlement by s.660A(6) ?

The court found that s.660A(6) did not save the arrangement from being a settlement. The first reason Mr Justice Park gave for that finding was that s.660A(6) only applied to gifts in the strict sense.

In the case of Arctic Systems, Mrs Jones had paid for her share. She only paid £1 for it but it was nevertheless bought rather than given to her by Mr Jones.

The second reason is that s.660A(6) provides that an outright gift is not itself a settlement but it does not provide that an arrangement constituting a settlement cannot include an outright gift. In other words where the entire arrangement consists only in the gift from one spouse to another of, for example, a house which is rented out, or of shares in a company which earn dividends, or simply of money which earns interest on deposit, s.660A(6) will apply.

But where the arrangement consists in more than one element, such as the gift by a husband of shares in a company, coupled with the husband working for the company for a salary far below his true earning power, s.660A(6) will not apply because the arrangement, though it includes an outright gift, comprises other elements in addition to that outright gift.

Conclusion

Many readers of this article will be wondering in the light of the decision of the High Court whether their own arrangements constitute a "settlement" and many will recognise similarities between their own circumstances and the circumstances of Arctic Systems as described.

However it should not be assumed that such similarities make it inevitable that there is a settlement – every case has slightly different circumstances.

Likewise it should not be assumed on the basis of this article that your own circumstances do not constitute a settlement as the description of what is a settlement given in this article has been simplified to a degree in order to explain the issues in the Arctic Systems case. It should also be borne in mind that it is possible that there may be an appeal from the decision of the High Court in this case to the Court of Appeal. If you are concerned about your own circumstances you should seek advice from a qualified lawyer (barrister or solicitor).

Article kindly provided by John Antell


John Antell is a barrister specialising in tax, contractual disputes (particularly those involving IT, engineering or construction) and in company and employment law.

Neither the author nor the publisher can be held responsible for any actions undertaken or not undertaken as a result of the opinions expressed in this article which are necessarily of a general nature and cannot be a substitute for individual legal advice on your own particular situation.

© John Antell 2005

www.johnantell.co.uk
 

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