Taxman 'won't let sleeping Arctics lie'

Four years worrying that the way they pay their tax may land them a retrospective bill of over £40,000 finally ended yesterday for 100,000 ‘husband and wife’ companies.

All five Law Lords unanimously crushed an attack on the tax-efficient structure of these firms, which are jointly owned by one revenue-earning spouse and one non-earning spouse.

Launched by HMRC, the attack singled out Arctic Systems by accusing its founder Geoff Jones, of unlawfully avoiding tax by deliberately paying himself a low salary to pass a larger share of profits to his wife.

Because Mr Jones, an IT contractor, generated earnings that ended up received by his wife, Diana, as dividends, HMRC argued he broke the law because less tax was paid.

Mr Jones argued that he was entitled to arrange his affairs in such a way, and yesterday, the Lords gave the final decision - he was indeed perfectly entitled to do so.

Only two judges - one a Special Commissioner, the other at the High Court - have agreed with HMRC out of the 11 judges who heard the case, “firmly vindicating” Mr Jones, one advisor said last night.

But the Lords’ judgement rejects HMRC's case on the basis that although the arrangment may have amounted to “settlement” under s660A, the issue of the share to Mrs Jones and from which she received dividends was an “outright gift”, making it exempt under the rule.

Even though Diana Jones bought her 50 per cent share in Arctic, the Lords treated the purchase as a ‘gift’ because it was only possible through Geoff allowing her to buy it.

The Lords ruling means that it doens't matter whether the non-earning spouse takes the shares directly from the company, or from the earning spouse - either way, it still ends up amounting to a 'gift' and ordinary shares are not “wholly or substantially a right to income,” within the meaning of s660A.

Lord Hope of Craighead explained: “So long as the shares from which that income arises are ordinary shares, and not shares carrying contractual rights which are restricted wholly or substantially to a right to income, the settlement will fall within the exception created by section 660A(6).”

Therefore the 1930s law does not apply to companies structured in this way that are jointly owned by married couples and civil partners, said the PCG , which backed Arctic Systems throughout its ordeal.

This means that contrary to the Revenue’s claims, the Joneses were free to declare dividends as they chose, without Mr Jones being liable to tax on his wife’s dividends.

Roger Sinclair, legal consultant at Egos Ltd, an advisor to the IT industry, summed up the effects of the Lords’ decision in its “broad terms” for the thousands of other firms with similarly tax structures .

He told Freelance UK: “The effect of the decision is that as the law presently stands husband and wife companies should be free to determine for themselves how they run their businesses and allocate profits, without falling foul of the ‘settlements’ legislation, in circumstances where the shares are ordinary shares and carry equal rights.”

Kate Cottrell, founder of Bauer & Cottrell, a specialist on s660A, welcomed the clarification of the settlements legislation, which has been muddied since 2003.

“After 4 years of uncertainty common sense has prevailed and we have a unanimous decision from the Lords,” Ms Cottrell told CUK last night.

But she cautioned that the government may yet have the final say: “This may not be a green light for giving shares to spouses, as in the medium to long-term HMRC may consider changing the law in support of their stance.”

Simon Dolan, founder of chartered accountant SJD Accountancy, agreed. He said HMRC is likely to press for new legislation that would head off future Mr and Mrs Joneses.

“The fact that the Revenue has pursued this case so far, and then lost, having been so sure of their position, indicates that they want to do something” to stop the tax treats enjoyed by husband and wife companies, Mr Dolan said in an interview with FUK.

He added: “Whether that means they are going to do something about one-person limited companies as a whole, or whether they will just address the tax circumstances of giving a share to your wife remains to be seen.”

Yet any attempt to legislate against husband and wife companies that have one spouse generally outside the marketplace would be fraught with difficulties.

Anne Redston, spokesperson for the Chartered Institute of Taxation, who has advised the Joneses, explained: “If HMRC bring in new rules, they will have to look at the question of which husband and wife businesses are they really going to attack, and on what grounds, and what evidence are they going to need?

“They may wish to change the law but it would be very difficult. Secondly, if they do wish to do it[legislate], it is absolutely imperative that they consult.”

If HMRC fails to open up to professional bodies, the chances of them correctly framing new tax rules to meet their intent “are pretty close to zero,” Ms Redston told FUK.

Moreover, despite advisors’ insistence last night that Jones V Garnett is a ‘test case’, the CIOT pointed out that the tax authority sees it differently.

“The Lords are only ruling for the past, they are not ruling for the future,” Ms Redston reminded.

“They’ve said that as it is [drafted] at the moment, this provision – s660A – does not apply to tax Mrs Jones. This will remain unless government and HMRC decide to change the law.”

If the taxpayer had lost yesterday, Her Majesty’s Revenue & Customs (HMRC) would change their view of the case immediately, Mr Dolan said after the judgement.

“Today we saw a common sense verdict… [but] as much as the Revenue said it wasn’t going to be a ‘test case’, evidently it was a test case, well to everyone else apart from the Revenue that is.

“Yet I’m sure they would have treated it as such if they had won, and opened up assessments on a huge number of taxpayers. Now they’ve lost, I’m sure they’ll say it wasn’t a test case,” he said, adding that HMRC is likely to stress that the verdict “only applies to certain people in certain circumstances.”

Since the decision, the department has issued a brief statement acknowledging the result and advising that they are considering the details of the judgement.

Former Inland Revenue inspector Kate Cottrell said: “In the short term HMRC will have to issue new guidance on settlements and outright gifts and most importantly the position for the taxpayer who has already paid up as soon as possible.”

SJD recommended: “If taxpayers have already paid up thinking they were caught by s660A they should go to the tax authority and ask for their money back.

“There’s no specific form for doing that, it’s just a matter of going to HMRC, making an amendment to your tax return, and saying ‘the dividends that I declared as mine actually belong to my wife.’”

The firm’s initial analysis suggests there is no reason why HMRC won’t return taxpayers’ money, and “even if they [the government] legislates, they can’t make any new laws retrospective.”

In a message to IT freelancers who run their own limited companies, Mr Dolan said: “Don’t change your tax affairs at the moment and don’t start giving shares away to your wife, because we’re not sure what the Revenue is going to do from hereon in.

“It’s a case of ‘wait and see’ over the next four weeks whether HMRC are going to raise any new legislation and if they don’t, which I think is very unlikely, then go ahead and start giving away shares, but there are caveats.”

Overall the Lords’ judgement is a victory for the taxpayer, but it is even more of a triumph for the Joneses, “because they stood to lose a great deal of money,” Mr Dolan said.

Asked about the future for small business taxpayers, Anne Redston reflected: “I very much hope relations with the tax authority will now have a chance to improve.

“Before the case really started, the professional bodies tried to get HMRC to look at the ‘common sense’ position.

“We have always preferred…to work with the Revenue, and small business organisations also would prefer to work with the Revenue, appropriately and straightforwardly and in a consultative way.”

She added: “We very much want the future to be one of cooperation and not confrontation.”

The Lords ruling is estimated to have cost the Exchequer one billion pounds in unrecoverable tax, while leaving HMRC facing a legal bill estimated at more than one million pounds.

Had the taxman won its appeal, between 100,000 and 300,000 small companies would have been taxed an additional one billion pounds, according to estimates from the CIOT and the PCG.


26th July 2007

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