Last week, I closed with a key question in the Arctic Systems case, namely, whether or not there was a settlement. If there was, then it would be necessary to go on to consider whether anti-avoidance provisions would mean that Mrs Jones’s dividends would be assessed on Mr Jones. Section 660G ICTA 1988 contains the important definition:
“(1) In this chapter, settlement includes any disposition, trust, covenant, agreement, arrangement or transfer of assets and “settlor”, in relation to a settlement, means any person by whom the settlement was made.
“(2) A person shall be deemed for the purposes of this chapter to have made a settlement if he has made or entered into the settlement directly or indirectly and, in particular but without prejudice to the generality of the preceding words, if he has provided or undertaken to provide funds directly or indirectly for the purpose of the settlement or has made with any other person a reciprocal arrangement for that other person to make or enter into the settlement.”
Lord Hoffman explained clearly that there must be bounty for there to be a settlement. Essentially, for there to be bounty, the settlor must provide a benefit which would not have been provided in a transaction at arm’s length.
In connection with Mrs Jones’s share, Sir Andrew Morritt stated in the Court of Appeal that value had been given for the £1 share and so there was no bounty. This was on the basis that “what happened thereafter, namely that Mrs Jones was paid a salary and in addition was paid dividends derived entirely from her husband’s work, was not part of the arrangement because these events depended upon the future business of the company and decisions on dividend policy by Mr Jones, all of which were uncertain. They could not therefore supply the necessary element of bounty.”
Lord Hoffman said that, in his opinion, to argue this was “divorced from reality”.
He said: “Mrs Jones could not have been issued with a share without the agreement of her husband and when he agreed to that arrangement, it was expected that he would take a low salary and that substantial dividends would be distributed. That was the advice which they had received from the accountant and that was what happened. Each year, the salaries were set at a level suggested by the accountant and the rest retained or distributed as dividend. The decisions were tax driven and not commercially driven. It was necessary, in order to gain the tax benefit, that Mr Jones should, in a broad sense, transfer some of his earnings to his wife.”
Lord Hoffman also said he could not agree that this was a “normal commercial transaction between two adults”. He said: “It made sense only on the basis that the two adults were married to each other. If Mrs Jones had been a stranger offering her services as a bookkeeper, it would have been a most abnormal transaction. It would not have been an arrangement into which Mr Jones would ever have entered with someone with whom he was dealing at arm’s length. It was only ‘natural love and affection’ which provided the consideration for the benefit he intended to confer on his wife. That is sufficient to provide the necessary element of bounty.”
At this point, all did not look good for the taxpayer. However, despite the existence of a settlement, there is a clear provision in section 660A(6) that a settlement for this purpose would not include an outright gift by one spouse to the other unless what is given is “wholly or substantially a right to income”.
It was agreed on behalf of the Revenue that the subject of the gift was such a right to income. There was some debate, however, over exactly what the property gifted was. One HMRC argument was that the gift was not of the share as Mr Jones never owned it, it having been subscribed for by Mrs Jones when the company was established. Lord Hoffman’s view was that this argument was misguided and there was a gift as Mr Jones consented to the issue of the share to Mrs Jones for £1. The gift was also outright.
Lord Hoffman went on to consider the second argument on behalf of HMRC. He said: “The second argument is that the transfer of the share was not the whole of the arrangement, which included the provision of services by Mr Jones, the dividend policy and so forth. Again, I think that would be inconsistent with the argument by which the Revenue have, in my opinion, succeeded on the first point. The transfer of the share was in my opinion the essence of the arrangement. The expectation of other future events gave that transfer the necessary element of bounty but the events themselves did not form part of the arrangement.
“Finally, the Revenue say that the property given, that is, the share, was wholly or substantially a right to income. It is true that the value in the share arose from the expectation that it would generate income but that is true of many shares, even in quoted companies. The share was not wholly or even substantially a right to income. It was an ordinary share conferring a right to vote, to participate in the distribution of assets on a winding up, to block a special resolution, to complain under section 459 of the Companies Act 1985. These are all rights over and above the right to income. The ordinary share is different from the preference shares in Young v Pearce (1996) 70 TC 331, which conferred nothing except the right to 30 per cent of the net profits before distribution of any other dividend and repayment on winding up of the nominal amount subscribed for their shares. Those shares were substantially a right in the income of the company.”