Section 660, the settlements legislation and Arctic Systems

The settlements legislation, in Section 660A of the Taxes Act 1988 and now in Chapter 5 of Part 5 of the Income Tax (Trading and Other Income) Act 2005, taxes income that a person has arranged to be paid to someone else as if it were still their own. It was written for trusts and gifts between spouses. From 2003 HMRC applied it to the ordinary family company: a contractor working through a company in which their spouse held shares, and dividends paid to both.

The Arctic Systems case

Geoff Jones, an IT consultant, and his wife Diana each held one share in Arctic Systems Ltd, the company through which he worked. He took a modest salary; the profits were paid as dividends to both. HMRC argued that the arrangement was a settlement and that Mrs Jones's dividends should be taxed as her husband's income. The couple lost before the Special Commissioners in 2004 and in the High Court in 2005, won in the Court of Appeal in December 2005, and won again, unanimously, in the House of Lords on 25 July 2007. The Lords accepted that the arrangement was a settlement but held that the gift of an ordinary share to a spouse fell within the exemption for outright gifts between spouses, so no charge arose. The case was funded by a fighting fund raised from contractors, at a cost the archive put at over half a million pounds across both sides.

Income shifting

The Treasury responded within days by announcing that it would legislate. The income shifting proposals published with the December 2007 Pre-Budget Report would have required family companies to justify each spouse's share of income by reference to their contribution, with a paper trail HMRC itself struggled to describe. The consultation drew the objections recorded in the archive from December 2007 onwards, the measure was deferred in the 2008 Pre-Budget Report, and it was never revived. The Arctic position, that ordinary shares held by a spouse carry their own dividends, has held since.

What remains caught

The exemption depends on the gift being of property that is not wholly or substantially a right to income. Preference shares that carry dividends and nothing else, dividend waivers that push income to the lower-earning spouse, and share classes created to carry income to one person are not protected by Arctic and remain the cases HMRC pursues. The distinction is the one every contractor accountant now draws when a company is set up.

Reading the archive

The articles below run from HMRC's first Section 660 enquiries through each stage of the Arctic litigation, the reactions to the Lords judgment, the costs, and the income shifting consultation that followed. They are the fullest contemporaneous record of the case that exists.