S660 - A brief history
The S660 rules (or settlements legislation) have been around since the 1930s.
The original rules stop you passing income to someone else in the family, or giving income or assets to someone else in an effort to reduce your overall tax bill. This is called a 'settlement', and the aim of the legislation is to stop people settling their income on another person who pays tax at a lower rate.
In such companies a husband and wife may, for example, each own an equal number of shares with one of them the main fee-earner and the other responsible for relatively little or no fee income. By paying out the profits by way of dividend, income earned by one of the couples can be partly received and taxed on the other resulting in an overall saving on tax since there will be two lots of personal allowance and basic rate tax band to use up. This is currently a very common scenario with thousands of husband and wife companies using what had always been deemed acceptable tax planning.
Previous years have seen uncertainty and confusion surrounding the taxation of family businesses with the case of Arctic Systems Ltd (Geoff and Diana Jones). The Revenue's argument was that if the wife's income stems mostly from the husband's work, then he has given her a right to his income, for example, the dividends that she gets on her shares in the Company, and therefore this should fall under S660 as a settlement.
Wilkins Kennedy told CUK the ‘husband and wife’ companies most at risk of being targeted by the Revenue were those viewed as openly abusing the dividend system. This was particularly true for when the main earner provided personal services and did not draw a market value salary. Which meant that the dividends were paid to shareholders paying tax at lower rates.
Controversially, Arctic Systems initially lost their case even though the decision was not unanimous. This resulted in a growing body of experts voicing a need for the decision to be challenged in a bid for clarity. Clouding the waters further, the Revenue said individual cases of settlement law would be decided on a case-by-case basis by considering the 'whole arrangement.' In the same year, the Revenue issued a 49-page advice document enforcing the taxman's controversial settlement legislation to 'prevent an individual from gaining a tax advantage,' through the transfer of assets. The document says the low-income partner should be taxed at his or her partner's rate of tax, which is more likely to be in the higher band tax rating.
Subsequently, the Joneses lost their High Court appeal in March 2005, with courts effectively dismissing a wife's contribution to such family businesses and ruling that such families cannot share both the rewards as well as the risks of that business. With the judgement highlighting Geoff Jones' salary, experts' advice was that if contractors wanted to keep 'off the Revenue's radar screen, paying a market rate salary would be sensible'.
The third decision in the long-running saga saw the Court of Appeal find in favour of the Joneses in December 2005. However, the HM Revenue & Customs decided to fight the unanimous ruling that Arctic Systems did not owe a retrospective tax bill a month later in January 2006. However, in July 2007, the House of Lords roundly rejected the appeal by HMRC. The PCG estimated that British taxpayers faced a bill of over half a million pounds for the cost of the taxman pursuing Arctic Systems Ltd over the controversial settlements legislation over the four year period.
'Income splitting' legislation
Just hours after the House of Lords voted in favour of Arctic Systems, the government announced plans to bring forward 'income splitting' legislation. This was to nullify the tax advantages that had been gained by the Jones' and thousands of others, but crucially this could not be retrospective.
In December 2007, the government published draft legislation 'focused specifically on income shifting arrangements that make use of companies or partnerships to gain a tax advantage.' The draft legislation stated the new rules would not apply if there was a "genuine commercial arrangement" and HMRC believes tax reduction was 'not the main or one of the main purposes' of the arrangement.
Otherwise, the rules, which are under consultation at the time of writing, will apply where one person 'shifts' trade or business income to another, with the effect being that less income tax is paid.
Under the legislation, taxpayers must detail how much income they have 'foregone' by making a comparison with how the business would have operated, had all their work been done independently on a fully commercial basis.
In the Chancellor's 2008 Budget speech, Darling announced the legislation was to be delayed until the Finance Bill 2009, and would not be enacted in April 2008.
More on S660.