Jones v Garnett (Inspector of Taxes)
| Jurisdiction | England & Wales |
| Judge | LORD HOPE OF CRAIGHEAD,LORD WALKER OF GESTINGTHORPE,LORD HOFFMANN,BARONESS HALE OF RICHMOND,LORD NEUBERGER OF ABBOTSBURY |
| Judgment Date | 25 July 2007 |
| Neutral Citation | [2007] UKHL 35 |
| Date | 25 July 2007 |
| Court | House of Lords |
[2007] UKHL 35
HOUSE OF LORDS
Appellate Committee
Lord Hoffmann
Lord Hope of Craighead
Lord Walker of Gestingthorpe
Baroness Hale of Richmond
Lord Neuberger of Abbotsbury
Appellants:
Michael Furness QC
Rupert Baldry
(Instructed by Solicitor's Office HM Revenue and Customs)
Respondents:
Malcolm Gammie QC
Keith Gordon
(Instructed by Nelsons)
My Lords,
Chapter IA of Part XV of the Income and Corporation Taxes Act 1988 contains anti-avoidance provisions intended in principle to prevent people from reducing their tax liabilities by settlements, gifts or similar arrangements which transfer income or income-producing assets to their minor children or under which they or their spouses retained an interest. These provisions go back many years.
The question in this appeal is whether they apply to the arrangements made by Mr and Mrs Jones to distribute the income of a company through which Mr Jones, with back-office support from Mrs Jones, traded as a computer consultant. When Mr Jones was made redundant in 1992, he decided to go freelance. He and his wife acquired a shelf company called Arctic Systems Ltd; the formation agents sold them the two issued £1 shares for £1 each and Mr Jones was appointed sole director. Mrs Jones was appointed secretary. It appears that the agencies through which computer consultants offered their services insisted upon dealing only with companies, presumably to avoid any possible argument that the consultant was in substance an employee.
The company then entered into contracts with customers to provide the services of Mr Jones. The performance of these services generated the company's income. Mrs Jones did the book keeping, dealt with the bank and the insurance company, paid tax and VAT and attended to correspondence. This took four or five hours a week.
The income was distributed on the advice of their accountant. The agreed statement of facts says that in the relevant year 1999-2000, the company's receipts were £78,355. Mr Jones took £6,520 as salary and Mrs Jones £3,600. The latter is accepted to have been a reasonable figure for Mrs Jones's services but the former figure is, given the company's receipts, plainly less than Mr Jones could have earned in the market. After these and other deductions, the company's taxable profits were £26,372, on which it paid £4,927 corporation tax. It is said to have declared and paid dividends of £25,767.25 to each of the shareholders, but given the amount of distributable profits, this may be a mistake. The precise figures do not however matter. The pattern of distribution over the previous years had been much the same.
The tax advantages to Mr and Mrs Jones of receiving the company's earnings as dividends rather than salary were, first, that National Insurance Contribution would have been payable on salary but was not payable on dividends and, secondly, that the dividend payable to Mrs Jones was taxable at a lower rate than it would have been if added to the income of Mr Jones. For these reasons, it was contemplated from the outset that the company would pay Mr and Mrs Jones low salaries and distribute the rest of its income as dividends.
The following are the provisions of Chapter IA which are said to apply to these arrangements:
660A.—(1) Income arising under a settlement during the life of the settlor shall be treated for all purposes of the Income Tax Acts as the income of the settlor and not as the income of any other person unless the income arises from property in which the settlor has no interest.
(2) Subject to the following provisions of this section, a settlor shall be regarded as having an interest in property if that property or any derived property is, or will or may become, payable to or applicable for the benefit of the settlor or his spouse in any circumstances whatsoever.
…
(6) The reference in subsection (1) above to a settlement does not include an outright gift by one spouse to the other of property from which income arises, unless—
(a) the gift does not carry a right to the whole of that income, or
(b) the property given is wholly or substantially a right to income.
For this purpose a gift is not an outright gift if it is subject to conditions, or if the property given or any derived property is or will or may become, in any circumstances whatsoever, payable to or applicable for the benefit of the donor.
660G.—(1) In this Chapter—
'settlement' Includes any disposition, trust, covenant, agreement, arrangement or transfer of assets, and
'settlor', in relation to a settlement, means any person by whom the settlement was made.
(2) A person shall be deemed for the purposes of this Chapter to have made a settlement if he has made or entered into the settlement directly or indirectly, and, in particular, but without prejudice to the generality of the preceding words, if he has provided or undertaken to provide funds directly or indirectly for the purpose of the settlement, or has made with any other person a reciprocal arrangement for that other person to make or enter into the settlement.
Not every transfer of property is a settlement for the purposes of section 660A. There has to be an "element of bounty" in the transaction. This old-fashioned phrase, apparently derived from the judgment of Plowman J in Commissioners of Inland Revenue v Leiner (1964) 41 TC 589, 596 and approved by the House of Lords in Inland Revenue Commissioners v Plummer [1980] AC 896, 913, conjuring up the image of Lady Bountiful in The Beaux' Stratagem, is perhaps not the happiest way of describing a provision for a spouse or minor children. A donation to a spouse or child is traditionally expressed in a deed to be "in consideration of natural love and affection" rather than the donor's bounty. It is nevertheless exactly the kind of thing at which the anti-avoidance provisions are aimed. In Chinn v Hochstrasser [1981] AC 533, 555 Lord Roskill cautioned against treating the word "bounty" as if it had been included in the statute. It seems to me that the general effect of the cases is that, under the arrangement, the settlor must provide a benefit which would not have been provided in a transaction at arms' length.
The Revenue's case is straightforward. They say that the acquisition of the company and the transfer of a share to Mrs Jones, enabling her to receive the dividends which were expected to be paid, was an arrangement. It was not a transaction at arms' length because Mr Jones would never have agreed to the transfer of half the issued share capital, carrying with it an expectation of substantial dividends, to a stranger who merely undertook to provide the paid services which Mrs Jones provided. That provided the necessary "element of bounty". The object of the arrangement was to keep the entire income within the family but to gain the benefit of using up Mrs Jones's lower rates. The dividends paid to Mrs Jones arose under the arrangement. Mr Jones, by working for the company, provided it with the funds which enabled the dividends to be paid. He was therefore a settlor within the meaning of section 660G(2). As Mrs Jones was the spouse of Mr Jones, he was to be treated as having an interest in the income derived from her share and that income was therefore to be treated as his income. I shall postpone consideration of why the Revenue say that the exception in section 660A(6) does not apply.
Park J accepted this argument but the Court of Appeal [2006] 1 WLR 1123 did not. Sir Andrew Morritt C said, at para 73, that Mrs Jones had acquired her share "for valu", i.e. for £1 "in the context of a joint business venture to which both parties made substantial and valuable contributions". What happened thereafter, namely that Mrs Jones was paid a salary and in addition was paid dividends derived entirely from her husband's work, was not part of the arrangement because these events depended upon the future business of the company and decisions on dividend policy by Mr Jones, all of which were uncertain. They could not therefore supply the necessary element of bounty.
I must respectfully disagree. In my opinion the analysis is divorced from reality. Mrs Jones could not have been issued with a share without the agreement of her husband and when he agreed to that arrangement, it was expected that he would take a low salary and that substantial dividends would be distributed. That was the advice which they had received from the accountant. And that was what happened. Each year the salaries were set at a level suggested by the accountant and the rest retained or distributed as dividend. The decisions were tax driven and not commercially driven. And it was necessary, in order to gain the tax benefit, that Mr Jones should, in a broad sense, transfer some of his earnings to his wife.
Authority for taking a broad and realistic view of the matter may be found in several cases of which the most relevant is Crossland v Hawkins [1961] Ch 537. This concerned section 397 of the Income Tax Act 1952, the effect of which is now reproduced in section 660B of the 1988 Act. It is, for all relevant purposes, in terms similar to section 660A, except that instead of applying when an interest under the settlement is retained by the settlor or his spouse, it applies when income arising under the settlement is paid for the benefit of a minor child of the settlor.
On 3 December 1954 the actor Jack Hawkins caused a company named Roehampton Productions Ltd to be formed with an authorised share capital of £100, of which two shares were subsequently issued to two clerks employed by his solicitors. On 10 December 1954 he agreed with the company to make his services available as the company should...
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