The Court of Appeal has resoundingly rejected the claims of the Revenue and found in favour of Arctic Systems, in a judgement issued yesterday (full text can be found here).
'In this case there can be no doubt but that the arrangement was or included the acquisition by Mrs Jones of her share in the Company. Equally there can be no doubt that that acquisition on its own was for full value in the context of a joint business venture to which both parties made substantial and valuable contributions. If the arrangement is confined to such acquisition then …it cannot constitute a settlement for the purposes of s.660G(1).' (para 73)
This decision represents the third (and hopefully final) round in a long running dispute, which began with the Revenue's attempt to reinterpret laws long in place designed to prevent a taxpayer from getting a tax advantage by diverting income to another. I understand that this long battle has been made possible by the ongoing support of the PCG, who deserve full credit for their efforts.
The Revenue had sought to reinterpret these laws in a way that would affect married couples jointly owning a company, in circumstances where the income of the company was directly generated by one only of them.
Unless the Revenue appeal to the House of Lords (possible, though unlikely), the law on this point is now settled.
I won't rehearse the background to the case in any detail – this has been amply covered elsewhere, and the case has been a subject of ongoing discussion and concern for more than 2 years amongst those likely to be affected by its outcome. The core elements were:
1. Husband and wife set up a company, with equal shareholdings, husband as director, and wife as company secretary.
2. Husband alone directly generated the company income.
3. Periods when the husband drew less than his 'market value' in salary whilst the wife was paid her market value in salary.
4. Profits were distributed to the shareholders as dividends.
The Revenue claimed that the overall effect of the above (earnings generated by the husband, ending up received by the wife as dividends) resulted in the husband obtaining a tax advantage, because less tax was paid – and so fell within the 'settlements' legislation, which (if established) would have had the effect of nullifying that advantage.
The legal questions addressed were:
Whether the circumstances of the case amounted to a 'settlement', within the meaning of the legislation; previous case law had established that for a settlement to exist, there have to be (at least) 'arrangements' incorporating an element of 'bounty'; and if so,
A. Whether the 'settlement' amounted to an 'outright gift', and if so
B. Whether that gift was 'wholly or substantially a right to income'.
Key points and quotes from the decision:
The Court would not 'ignore the increasing tendency for married couples to be involved in the business of each other on a commercial non-bounteous basis…Though one spouse may generate the income of the firm or company, the services of the other may be just as commercially important in providing the essential administrative, accounting, support and backup services.' (para 70)
'the efforts of Mrs Jones must have contributed to the success of the Company.' (para 84);
'for a commercial venture such as existed in the present case to be brought within the scope of the settlement provisions would represent an unjustified extension of their scope.' (para 103)
'For the first time, (the Revenue) seek to apply the (settlements provisions) to what has been found to be a normal commercial transaction between two adults, to which each is making a substantial commercial contribution, albeit not of the same economic value. Such a difference, by itself, is not enough to my mind to take the arrangement into the realm of "bounty", as it has been understood in the existing cases.' (para 108)
'The pointers to the existence of bounty have been variously described as "a taxpayer gives away a portion of his income, or of his assets", "a flavour of donation" or "the recipient benefits without any assumption by him of any correlative obligation".' (para 72)
The 'corporate set-up gave him the ability to confer benefit, but, of itself, did not do so.' (para 74); 'if a structure is created with the intention to provide bounty then that is sufficient to provide the requisite element of bounty. But this assumes that the satisfaction of all the conditions necessary for that intention to be fulfilled are part of the arrangement. For the reasons I have already given I do not think that they were.' (para 85); 'The fact that a profit and a dividend may result is not in my view enough, nor do I think it is contemplated by the decided cases.' (para 86); 'those matters which constitute the arrangement and hence the settlement must be identifiable by a particular point in time, as opposed to there being something which may or may not turn out to be a settlement if certain future events happen :' (para 101) – those matters were 'too speculative and uncertain' (para 102)
Existing case law was reviewed and distinguished from the facts in the present case – in many of those cases 'The beneficiaries under the actual settlements …contributed nothing.' (para 77)
In another earlier case, the facts and events were 'all part of a single arrangement in which there was both unity and bounty.' (para 79)
In other cases, certain of the events that had occurred had 'no business purpose whatever. The element of bounty was clear' (para 80), or were 'clearly parts of an arrangement and the element of bounty was conceded' (para 81)
A key point was that there was no formal service agreement under which Mr Jones committed himself to working for the company at less than his 'market value' - 'He did not commit himself to working for the Company at any particular rate of salary or at all.' (para 75); and 'In the absence of any service agreement between the Company and Mr Jones I am unable to accept that the payment of modest salaries to Mr Jones was any part of the arrangement.' (para 83). Of another earlier case where there had been held to be a settlement, 'The service agreement was an integral part of the arrangement.' (para 88)
In the earlier stages of this case, the Revenue's case had depended in part Mrs Jones having been paid at market value for her own contributions – but here it was observed that 'What they eventually drew by way of salary seems to have depended on how well the company performed and on other factors, and in the event there were years when Mrs Jones drew no salary at all, enjoying no remuneration for her work as an employee. On his side the appellant was not obliged to work for the company at less than the market rate, and it seems that in the years 2000 – 2001 and 2001 – 2002 he decided to take a full salary. What happened in practice was therefore dependent on subsequent decisions made by the appellant as the sole director. It is difficult to regard such a Protean state of affairs as capable of being part of an arrangement in the sense used in the legislation. Furthermore, for the same reasons the element of bounty also was too speculative when viewed as at the date of the alleged settlement.' (para 102)
Looking at the arrangements as a whole (which the Revenue had to show fell within the legal meaning of the term 'settlement', if they were to succeed): 'their uncertainty and fluidity is the converse of an arrangement. It is not that they were not legally enforceable, they were not settled at all. No doubt Mr and Mrs Jones hoped for the best but it cannot be said that they had arranged it. Without these elements there was no element of bounty and no settlement within the statutory definition.' (para 76)
A gift "'wholly or substantially' of 'a right to income'"?
A share in a company subscribed directly by Mrs Jones could not be regarded as an 'outright gift' from her husband, the co-shareholder (if there had been a settlement, this point could have been significant) (para 93)
An ordinary share in a company was clearly more than just a right to income – 'Each share carries a right to share in dividends duly declared. In addition each share carries the right to share in the distribution of assets in the event of a members' winding up and the right to vote at general meetings of the Company. The rights attaching to the ordinary shares in the Company are unaffected by the alleged arrangement.' (para 97) (again, if there had been a settlement, this point could have been significant)
In broad terms, the effects of this decision are that husband and wife companies should be free to determine for themselves how they run their businesses and allocate profits, without falling foul of the 'settlements' legislation, in circumstances where
the party directly generating the income makes no ongoing commitment to work for less than 'market value'; and
both parties genuinely contribute towards the operation of the business.
If in doubt – get advice!
Article kindly provided by Roger Sinclair