House of Lords
Published August 9, 2007
Jones v Garnett (Inspector of Taxes)
Before Lord Hoffmann, Lord Hope of Craighead, Lord Walker of Gestingthorpe,
Baroness Hale of Richmond and Lord Neuberger of Abbotsbury
Speeches June 25, 2007
A spouse who used a private company to transfer some of his earned income to
the other spouse was not liable to pay tax on that income, provided the
other spouse’s shares in the company were ordinary shares which carried a
right to more than mere income.
The House of Lords so held in dismissing an appeal by the Inland Revenue from
a decision of the Court of Appeal (Sir Andrew Morritt, Chancellor, Lord
Justice Keene and Lord Justice Carnwath) (The Times January 3, 2006;
[2006] 1 WLR 1123) allowing an appeal by the taxpayer, Geoffrey Peter Jones,
from Mr Justice Park (The Times May 17, 2005; [2005] STC 1667), who
upheld the dismissal by special commissioners (Dr Nuala Brice and Ms Judith
Powell) ([2005] STC (SCD) 9) of the taxpayer’s appeal, on the presiding
commissioner’s casting vote, against a notice of amendment of
self-assessment for 1999-2000, whereby dividends paid to the taxpayer’s
wife, as a shareholder of Arctic Systems Ltd, were treated for income tax
purposes as the income of the taxpayer as settlor.
Section 660A of the Income and Corporation Taxes Act 1988, as inserted by
section 74 of, and Schedule 17 to the Finance Act 1995, provides:
“(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) ... a settlor shall be regarded as having an interest in property if that
property or any derived property is, or will or may become, payable to or
applicable for the benefit of the settlor or his spouse in any circumstances
whatsoever . . .
“(6) The reference . . . above to a settlement does not include an outright
gift by one spouse to the other of property from which income arises, unless
- . . . (b) the property given is wholly or substantially a right to income
. . .”
Section 660G provides: “(1) In this chapter -‘settlement’ includes any
disposition, trust, covenant, agreement, arrangement or transfer of assets .
. .”
Mr Michael Furness, QC and Mr Rupert Baldry for the Revenue; Mr
Malcolm Gammie, QC and Mr Keith Gordon for the taxpayer.
LORD HOFFMANN said that Mr Jones and his wife acquired a shelf company; the
formation agents sold them the two issued £1 shares for £1 each. The company
then entered into contracts with customers to provide the services of Mr
Jones as a computer consultant which generated the company’s income. Mrs
Jones did the bookkeeping and performed other administrative tasks which
took four or five hours a week.
Both Mr and Mrs Jones took small salaries but the company declared and paid
large dividends to each of them as shareholders.
The tax advantages to the couple of receiving the company’s earnings as
dividends rather than salary were, first, that National Insurance
contribution would have been payable on salary but was 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.
Not every transfer of property was a settlement for the purposes of section
660A. There had to be an “element of bounty” in the transaction. That
old-fashioned phrase (see Inland Revenue Commissioners v Plummer
([1980] AC 896, 913) was perhaps not the happiest way of describing a
provision for a spouse or minor children.
A donation to a spouse or child was traditionally expressed in a deed to be
“in consideration of natural love and affection” rather than the donor’s
bounty. It was nevertheless exactly the kind of thing at which the
antiavoidance provisions were aimed.
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.
The decisions were tax-driven and not commercially driven.
And 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.
It was not a normal commercial transaction between two adults. 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 arms’ length. It was only
natural love and affection which provided the consideration for the benefit
he intended to confer upon his wife. That was sufficient to provide the
necessary element of bounty.
However, section 660A(6) created an exception for cases in which one spouse
made an outright gift to the other of the property from which the income
arose. The Revenue said that the exception did not apply to that transaction.
First, they said there was no gift of the share by Mr Jones to Mrs Jones. He
never owned the share which she took. It belonged to the formation agents
and Mrs Jones bought it from them for £1.
His Lordship said that narrow analysis of the transaction would be
inconsistent with the reasoning by which the transfer came within section
660A in the first place.
It was Mr Jones’s consent to the transfer of a share with expectations of
dividend to Mrs Jones for £1 which gave the transfer the element of bounty
for the purposes of section 660A. By the same token, it made the transfer a
gift for the purposes of subsection (6). And there was no dispute that, if
it was a gift, it was outright.
The second argument was 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, that would be inconsistent with the argument by which the Revenue had
succeeded on the first point. The transfer of the share was 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 said that the property given, namely, the share, was
“wholly or substantially a right to income”.
It was true that the value in the share arose from the expectation that it
would generate income. But that was 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. Those were all rights
over and above the right to income.
The ordinary share was 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 to share in the income of the
company.
The instant arrangement fell within the exception in section 660A(6).
Lord Hope, Lord Walker, Lady Hale and Lord Neuberger delivered concurring
opinions.
Solicitors: Solicitor, Revenue and Customs; Nelsons, Leicester.
