Detailed analysis on the Arctic S660 appeal
Mr and Mrs Jones formed a company for the husband's computer business. He purchased, on the advice of his accountant an off the shelf company - Arctic Systems Ltd. He purchased 1 ordinary £1 share, and she for the other. He was sole director and she the secretary. He then obtained contracts and worked as a computer contractor, and she ran the administrative side. They paid themselves low salaries and paid out the remaining profits as dividends, apart from a couple of years when Mr Jones believed he came under IR35, when he paid himself the resultant "deemed payment". The wife’s input to the business was far less than that of the husband, and all turnover was derived from his work.
The Inland Revenue believe that this type of business set-up is an arrangement in the nature of a settlement. It is very similar to their examples of settlements in their published interpretations of the settlement legislation. It is clear that service companies run by husbands and wives (and couples, under the Civil Partnership Act 2004) are prime targets for the Revenue in this area.
The Special Commissioners hearing - 2004
The Inland Revenue took the case to the Commissioners. Arguing that dividends received by Mrs Jones were income arising from a settlement, and should therefore be taxed on Mr Jones who was the settlor of that settlement. The two commissioners at the hearing - Dr Brice (presiding) and Ms Powell virtually disagreed on all points, and a stalemate was produced. Dr Brice then exercised her second vote or casting vote, and this too was controversial - should it have been a second vote, or should a casting vote be exercised in another way? If it was a second vote, then why have two commissioners in such proceedings?
The Appeal in the High Court - 16th March 2005
Mr Justice Park hearing the appeal, with Mr Malcolm Gammie for Mr Jones and Mr Rupert Baldry for the Inland Revenue.
To re-cap, this is the case of a computer consultant and his wife, who have apparently fallen foul of semi-dormant settlement legislation in s.660A ICTA 1988.
By jointly owning their company, they have been able to take lower than market rate salaries, and share the company's profits, thus enjoying the ensuing tax advantages jointly.
The Inland Revenue has objected to this, because Mr Jones is the main source of the company’s income. They Revenue have revived an attack dog, awoken from almost a decade of sleep to counter this, and are hoping to make the settlement legislation in s.660A ICTA 1988 bite on the Joneses. Of course, if they succeed, over a hundred thousand other husbands and wives in business may fall victim to discovery assessments.
Mr Malcolm Gammie opened for the taxpayers, Mr and Mrs Jones.
Up for consideration was the matter of the casting vote of Dr Brice at the Special Commissioners' Hearing:
1. Did she exercise her vote properly?
2. Should she have exercised her vote in the favour of the defendant (Mr Jones)?
3. Did she reach a correct decision on the settlement?
He could find little authority as to how a tribunal chairman should use a casting vote in law as the Special Commissioners Jurisdiction Procedure Regulations give few details.
He was only able to refer to two Local Authority cases concerning Bradford City Council.
His suggestion was that a casting vote should be exercised in the best interests of persons affected by the vote, and should apply as follows:
- If the Inland Revenue was seeking to bring a taxpayer into the scope of tax, a casting vote should find for the taxpayer, conversely,
- If the taxpayer was seeking to claim a relief, the casting vote should be in favour of the Inland Revenue.
Park J. was perplexed as to why he should not refer this back to Dr Brice for re-consideration, under the terms of a judicial review. Mr Gammie replied that:
- It was important for proceedings that this situation with the Special Commissioners should be resolved, and this was an opportunity where some guidance could be gained for the future.
- Neither party were keen on a judicial review in this case, and,
- There were not the funds available to deal with one as well.
Mr Gammie felt that neither Special Commissioner had given reasons as to why they had applied the casting vote as if it gave Dr Brice two votes.
He ended his examination of this area with the following questions unresolved:
- Was Dr Brice more of a specialist than Ms Powell? If so, did this mean that she was entitled to use her vote as a second vote, or,
- Should she have used her casting vote for the persons affected by that vote?
- Who stood to be affected by her casting vote? The Jones, or the Inland Revenue, representing taxpayers in general?
Turning to what everyone regards as the more interesting side of the case, that concerning s.660A, Mr Gammie commenced to look into the question as to whether there was a settlement, was there any bounty in existence, and did parliament really mean s.660A to apply to husbands and wives in business together, in any case?
This took us in a circular motion, Mr Gammie was not wrong when he told the court "that the legislation had become a little odd."
This takes us into day two, and then Mr Baldry will take up the case for the Revenue.
Day 2 "A taste of bounty"
Mr Gammie for the appellants (Mr and Mrs Jones) continued his detailed look at the type of arrangement, which can be classed as a settlement for the purposes of s.660A ICTA 1988. The emphasis being that a purely commercial arrangement, without any element of bounty would not fall within these provisions.
Of course, the argument is that there was no settlement in any case, but since the Inland Revenue will be arguing the opposite view, it was necessary to trawl through all the authorities (past case reports) on or near the point.
Park J. queried various aspects of arrangements between husbands and wives, using illustrative examples, along the lines of "what if you had a company where the husband and wife each own x% of shares..."? Mr Gammie's careful suggestions often served to illustrate the absurd results that could be achieved if the decision of the Special Commissioner, Dr Brice remained undisturbed. Echoing his proposition that Dr Brice had come to not only an incorrect decision, but also that following her line of argument would produce an unworkable tax system for married couples in business. Hardly something that could have been intended by Parliament when separate taxation was introduced.
Mr Baldry commenced for the Inland Revenue mid afternoon with a run through the procedural aspect. This was to show why, the Revenue’s view, the Special Commissioners had applied the second or casting vote correctly:
- The Presiding Commissioner has full judicial discretion as to how he/she should exercise a casting vote under Regulation 18(2) of Commissioners Procedures.
- That discretion should not be affected by any practices adopted prior to 1994.
- The legislative purpose of Reg. 18(2) was:
- To enable the presiding commissioner to end a deadlock, and
- To end the practice of withdrawing in favour of either the Inland Revenue or the taxpayer, (if this had ever occurred in any case).
- The Regulations did not set out a requirement for the presiding commissioners to justify the reasons for a casting vote.
- Only limited assistance could be gleaned from the Local Authority cases, they just confirmed a duty to act honestly.
- In the present case, there was no evidence that Dr Brice did not exercise her discretion properly, and nothing can be derived from her failure to examine her reasons – she was not obliged to.
He felt that all this was of academic interest only, and since there is to be no judicial review of this apparent problem, we must await the judgment in the case, to see what if anything can be gleaned for the future.
Mr Baldry turned to "the interesting side of the case", the Inland Revenue's two questions:
1. Were the dividends paid to Mrs Jones income arising from an arrangement under the settlement provisions?
2. Is that arrangement excluded from the settlement provision by s.660A (6)?
Naturally, the Inland Revenue feels that the correct answers are "yes" to the first question, and "no" to the second question.
We ended the day in a similar way to that in which we started it, a look through the legislation and then back to the leading authorities on the question of "bounty".
Day 3 - Conundrums and hobby horses
The final day in this appeal hearing left me feeling quite drained. Geoff and Diana Jones were quiet and the team of Malcolm Gammie QC, PCG, Accountax, and Earnst and Young, hardly chatty. Mr Justice Park thinks it unlikely that he will be able to reach any conclusions for at least four weeks. This is partly due to the complexities of the case, and party due to Easter and other work commitments.
Mr Rupert Baldry ran through the Revenue's main points, continuing from the day before, these were as follows:
1. Were the dividends paid to Mrs Jones income arising from an arrangement under the settlement provisions?
2. Was that arrangement covered by the exemption in s.660A (6)?
He continued to look at the authorities on settlements, arrangements and dispositions, and then to go through Mr Gammie’s case, with that of Miss Powell's judgement.
In asking questions directed by Park J, it became very clear that the Revenue were interested in this case because of the nature of the business – a personal service company. Mr Baldry would not be drawn as to the fate of other types of husband and wife business in conjunction with the settlements provisions if the Revenue wins this case, although Park J expressed an interest. It is fair to say that all observers realise that this is yet another attack on personal service companies.
In order to explain the conundrum now faced by Mr Justice Park, it is easiest to express what this case is not wholly about:
It does not concern an outright gift of a share in a company. If Mr Jones had formed a company, taken on a contract, and then given his wife 50% of the company, the question would have been more straightforward. It would have been whether Mr Jones could take advantage of this exemption for outright gifts in s.660A (6)? This would have lead to a good look at whether or not an ordinary share in a personal service company is wholly or substantially a right to income.
The case is not like that though, as Mr Jones did not gift an actual share. He and his wife subscribed to a share each in an off-the-shelf company before any contract was under taken. No shares were gifted. What was gifted, if anything was Mr Jones’ time, and income earning capacity to a company, from which Mrs Jones could partake in the profits as a shareholder. Was that a gift, or just someone running a business through a company? After all, is that not what anyone does when they work for a company when there are other shareholders?
If it was a gift, is there actually bounty in terms of the settlement legislation? Here we are looking at the manner in which Mr Jones split his income with his wife. What about the settlement, if there is one? Did it commence with the formation of the company? It seems problematical, because Mrs Jones subscribed in her own right. So perhaps the settlement was created after that, when Mr Jones started to work for the company. But, in determining a settlement, one looks at the arrangement in the round. Excluding the share, his gift was his time, and how can you tax income that comes from such an unusual type of property?
It is very easy to go round and round in complete circles over this, and this is precisely why the Special Commissioners could not agree, and why Mr Justice Park is going to have quite a difficult time in preparing a judgement.
We think it quite likely that the Revenue will be unlikely to accept defeat in this case.
Nichola Ross Martin FCA BA (Hons) March 2005
1st April 2005