Arctic Systems - victory to the taxpayer

At last a victory for the taxpayer against Her Majesty’s Revenue and Customs (HMRC).

In a judgement released in late July, the House of Lords held that HMRC was wrong to charge Geoff Jones tax as if dividend income paid to his wife from their company, Arctic Systems Limited, was his income. Geoff and Diana jointly owned the company, but Geoff did the fee-paying work whilst Diana dealt with the administration. After paying modest salaries to both of them, the company made a profit, paid its corporation tax, and distributed the balance equally by way of dividend. There were substantial National Insurance and income tax advantages in structuring their affairs this way.

However, HMRC claimed that the whole arrangement constituted a ‘settlement’ in which Geoff was the settlor and Diana was a beneficiary, and that Section 660A ICTA 1988 should apply to treat Diana’s dividend income as Geoff’s. The Joneses contended that either there was no ‘settlement’ or, if there was, the Section didn’t apply to them because of the escape clause in S660A(6) i.e. there was more than the mere transfer of a source of income; there was an outright gift of a share in Arctic Systems Limited, with all the rights that naturally followed.

The case was interesting for all sorts of reasons, not least because on the one hand, the High Court agreed with HMRC that the arrangements constituted a settlement and that the escape was not available; but on the other, the Court of Appeal agreed with the Joneses that the arrangements did not constitute a settlement. Ultimately, the House of Lords agreed with HMRC that the arrangements constituted a settlement, but agreed with the Joneses that the escape was available to them!

So what does this mean? In summary, the decision confirms that it is possible for a couple to set up a joint company and for only one of them to generate the income, but for both of them to share this income as a dividend. However, it will not be sufficient for one of the spouses to have only income-producing shares, as the judgement makes it clear that this arrangement would be a settlement and the escape clause would not be available.

However, victory may be short lived. The lawyers acting for HMRC said, “It is very possible that the Government will introduce legislation to close this loophole…it is not justified and it would be relatively easy for action to be taken.” It seems once more we may find the Government moving the goalposts in the face of an adverse decision in the courts.