Section 660: Where the Commissioners disagreed

Details are emerging that the two Special Commissioners in the Arctic Systems Section 660 case disagreed on several important aspects of the case.

The case went in favour of the Inland Revenue dealing a significant blow to the small business community. However, the two Commissioners disagreed with each other and it was only the fact that the senior of the two, Dr Nuala Brice, held the 'casting vote' that the Revenue won.

Practitioners will be studying the judgment in detail to see what aspects of it can be helpful to small businesses and to discover where there is scope for further discussion with the Revenue.

Sole director

Arctic Systems is owned by Geoff Jones and his wife Diana. Dr Brice's decision to find in favour of the Revenue seems to have been influenced by the fact that Mr Jones was the sole director and therefore had the right to declare dividends. The Commissioner was also swayed by Mrs Jones's lack of an absolute right to transfer her share.

Anne Redston, tax partner at Ernst & Young, said: "Dr Brice's decision appears to depend to a considerable degree on the fact that Mr Jones was the only director and so had the sole right to declare dividends. She also puts more value on Mrs Jones's lack of an absolute right to transfer her share. Had these factors not been present, it appears that her decision may have been different.

"This may be a point to discuss with the Revenue in terms of interim guidance, so that we can exclude from S660A those cases where these factors are not present. It would however make nonsense of S660A if, in a family company, the mere appointment of both individuals as directors could circumvent the legislation."

Seven questions

Dave Smith of Accountax Consulting was part of the legal and advisory team representing Arctic Systems. He has examined the judgment, which is described as a long and detailed document.

According to Mr Smith, presiding Special Commissioner Dr Nuala Brice identified seven questions and found against the Joneses on every one of them, whereas Miss Judith Powell, the second Commissioner, reached an opposite conclusion on almost every point, a deadlock resolved by Dr Brice exercising her casting vote.

Dr Brice considered the whole situation - from purchase of the company through Geoff’s low salaries and the subsequent payment of dividends - to constitute an 'arrangement'. In her view, the property comprised in the settlement was the share held by Mrs Jones, and her holding of the share was part of the arrangement; she held it through the bounty of Geoff, in whose gift it was to let her acquire a share.

The dividend income paid to Mrs Jones was a recognised source of income for income tax purposes, and thus qualified as 'income arising under a settlement'. Accordingly, Dr Brice found all the criteria needed for Diana’s dividend income to be taxed as Geoff’s income, and had only to consider whether the exemption available for outright gifts between spouses could apply. She ruled that it could not, because the declaration of dividends was in Geoff’s power, and would be of little value to anyone other than Diana, rating it as 'wholly or substantially a right to income,' and therefore excluded from the exemption.

Opposite view

Miss Powell took the opposite view on almost every point. Whilst conceding that the purchase of a share might constitute a statutory settlement, she concluded that in this scenario it did not. At the time of the share being sold, Geoff was not bound to work for the company, or pay himself less than a market salary or declare dividends. He was not worse off at the time merely because he intended to provide bounty in the future if the opportunity arose. Thus, when Mrs Jones bought the share, it was not part of an 'arrangement' that could qualify as a settlement.

Even though the share might be subject to conditions, the gift of it was not, and at that early stage in a company’s life no-one could tell whether it would indeed become a source of income in the future. Miss Powell felt that even if the share could be classed as settled property within the arrangement caught by the act, it was exempted as a qualifying gift. She also viewed ordinary shares, with the bundle of rights that they carry, as being different from dividend-only preference shares, and that in light of this, Diana Jones’s share was not wholly or substantially a right to income.

Parliament's intentions

Both Commissioners considered whether Parliament had intended, when introducing independent taxation for married persons in 1990, that arrangements such as these would be classified as statutory settlements. Dr Brice noted that the exemption was for outright gifts of income-producing assets which were neither 'wholly or substantially a right to income' nor subject to conditions, and ruled that Geoff’s gift of a share did not qualify for exemption.

Miss Powell, however, felt that it could not have been the intention of Parliament to encourage absolute gifts between spouses to equalise assets whilst at the same time treating those gifts differently depending on their timing, that is, before or after they had become valuable. Her conclusion was that the gift of shares at the outset of a venture was never intended to be caught at all and hence did not need to be exempted.