So at last we know. Him and Mrs Jones had a thing going on – and it worked. Well, for them. But having suffered defeat in the courts, true to form, the Treasury will be looking to get its own way in the future by amending the rules. Is it just my imagination or have we passed this way before? There is a strong temptation to ask David Ruffin. Three song references in one paragraph. Not bad.
In the House of Lords, the Law Lords unanimously agreed that the dividends paid to Mrs Jones as a shareholder should not be assessed to tax on Mr Jones. You will, I am sure, have at least a superficial understanding of the facts of the case. But for those of you who need a reminder, I can do no better than to quote Lord Hoffman’s summing up of the facts.
“Chapter 1A of Part XV of the Income and Corporation Taxes Act 1988 contains anti-avoidance provisions intended in principle to prevent people from reducing their tax liabilities by settlements, gifts or similar arrangements which transfer income or income-producing assets to their minor children or under which they or their spouses retained an interest. These provisions go back many years.
“The question in the appeal was whether they apply to the arrangements made by Mr and Mrs Jones to distribute the income of a company through which Mr Jones, with back-office support from Mrs Jones, traded as a computer consultant. When Mr Jones was made redundant in 1992, he decided to go freelance. He and his wife acquired a shelf company called Arctic Systems Ltd. The formation agents sold them the two issued £1 shares for £1 each and Mr Jones was appointed sole director. Mrs Jones was appointed secretary.
“It appears that the agencies through which computer consultants offered their services insisted upon dealing only with companies, presumably to avoid any possible argument that the consultant was in substance an employee.
“The company then entered into contracts with customers to provide the services of Mr Jones. The performance of these services generated the company’s income. Mrs Jones did the bookkeeping, dealt with the bank and the insurance company, paid tax and VAT and attended to correspondence. This took four or five hours a week.
“The income was distributed on the advice of their accountant. The agreed statement of facts says that in the relevant year 1999-2000, the company’s receipts were £78,355. Mr Jones took £6,520 as salary and Mrs Jones £3,600. The latter is accepted to have been a reasonable figure for Mrs Jones’s services but the former figure is, given the company’s receipts, plainly less than Mr Jones could have earned in the market.
“After these and other deductions, the company’s taxable profits were £26,372, on which it paid £4,927 corporation tax. It is said to have declared and paid dividends of £35,676.25 to each of the shareholders but given the amount of distributable profits, this may be a mistake. The precise figures do not however matter. The pattern of distribution over previous years was much the same.
“The tax advantages to Mr and Mrs Jones of receiving the company’s earnings as dividends rather than salary were, first, that National Insurance contributions would have been payable on salary but were not payable on dividends and, second, that the dividend payable to Mrs Jones was taxable at a lower rate than it would have been if added to the income of Mr Jones. For these reasons, it was contemplated from the outset that the company would pay Mr and Mrs Jones low salaries and distribute the rest of its income as dividends.”
The key legislation was that in section 660A ICTA 1988 which applies to treat income arising under a settlement during the life of the settlor as that of the settlor for all income tax purposes. Relevant parts of section 660A are reproduced here:(1) Income arising under a settlement during the life of the settlor shall be treated for all purposes of the Income Tax Acts as the income of the settlor and not as the income of any other person unless the income arises from property in which the settlor has no interest.(2) Subject to the following provisions of this section, a settlor shall be regarded as having an interest in property if that propertyor any derived property is, or will or may become, payable to or applicable for the benefit of the settlor or spouse in any circumstances whatsoever.(6) The reference in subsection (1) above to a settlement does not include an outright gift by one spouse to the other of property from which income arises unless:
(a) the gift does not carry a right to the whole of that income or(b) the property given is wholly or substantially a right to income.
For this purpose, a gift is not an outright gift if it is subject to conditions or if the property given or any derived property is or will or may become, in any circumstances whatsoever, payable to or applicable for the benefit of the donor.
The first thing to decide was whether there was a settlement. Without a settlement, there would be no case to answer. More next week.