Patmore v HM Revenue and Customs
| Jurisdiction | UK Non-devolved |
| Judgment Date | 14 July 2010 |
| Neutral Citation | [2010] UKFTT 334 (TC) |
| Date | 14 July 2010 |
| Court | First Tier Tribunal (Tax Chamber) |
[2010] UKFTT 334 (TC)
Barbara Mosedale (Tribunal Judge) (Chairman)
Mr R McMorran, Chartered Certified Accountant, for the Appellant
Mr R Baldry, Counsel, instructed by the General Counsel and Solicitor to HM Revenue and Customs, for the Respondents
Direct tax - husband and wife jointly fund share purchase - over 97% shares purchased transferred to husband - new class of shares allotted to wife - wife receives approximately 40% of dividends - whether settlement under ICTA 88, Income and Corporation Taxes Act 1988 section 660As. 660A
The taxpayer was not liable to higher rate tax in respect of dividends paid to his wife on shares in a company they owned since the dividends did not constitute income arising under a settlement for the purposes of ICTA 1988, Income and Corporation Taxes Act 1988 section 660As. 660A.
The taxpayer and his wife purchased a small engineering company, of which he was a director, for the sum of 320,000 on the retirement of its controlling shareholder. The purchase was funded partly by a mortgage on their home which they owned jointly. Following the purchase, although the wife was equally liable for the loans raised to purchase the company, she received a much smaller percentage of the shares in the company than the taxpayer. The company's shares were reorganised into two classes, with the wife owning two per cent of the A shares and 10 per cent of the non-voting B shares, in respect of which dividends were paid in the tax years 1999 to 2003. Those dividends were always paid immediately into the taxpayer's loan account to set against the outstanding payments in relation to the purchase of the company.
HMRC took the view that, under that arrangement, the taxpayer was liable to tax on the dividends paid in respect of the B shares as the settlor under a settlement within ICTA 1988, s. 660A, on the basis that the taxpayer owned the company and used his control of it to declare significant dividends in favour of his wife so that they would attract a lower rate of tax. However, his wife never received the dividends as effectively they were always retained by the taxpayer to repay the purchase debt. Accordingly, HMRC issued amendments to the taxpayer's self-assessments for the relevant years, increasing his tax liability on the ground that the dividend income paid to his wife was income arising under a settlement on which the taxpayer was liable to tax at the higher rate.
The taxpayer appealed, arguing that the share structure had been reorganised to protect his wife from some of the risk inherent in the company but to give her a fair share of the dividends.
Whether the dividends paid to the wife were income arising under a settlement within ICTA 1988, s. 660A(1).
The First-tier Tribunal (Barbara Mosedale) (allowing the taxpayer's appeal in part) said that a settlement included an arrangement. The decision of the court in Jones v Garnett (HMIT)TAX[2007] BTC 476 (Arctic Systems Ltd) indicated a broad interpretation: relatively valueless shares which were given to a spouse in circumstances where it was intended future dividends would be paid on them could amount to an arrangement. A relatively simple plan to use a company's shares to divert income fell within the meaning of an arrangement. Under the arrangement, the settlor had to provide a benefit which would not have been provided in a transaction at arm's length (Bird v R & C CommrsSCD(2008) Sp C 720 considered).
Taking a broad and realistic view of the arrangements, on the evidence, there was a constructive trust in the wife's favour. She contributed half of the capital to buy the shares by being jointly liable with her husband on the purchase loan and on the mortgage of the jointly owned house. The purchase of the company was a joint enterprise by the taxpayer and his wife to secure their financial future. The wife did not intend to give her half-share to her husband. They just took the advice of their accountant, which they did not fully understand, which was to allot to her B shares rather than transfer to her half of the 85 A shares which they had jointly purchased. The B shares were not a fair recognition of her investment as they were almost valueless, carrying no rights to vote nor rights to a dividend (any dividend paid was paid entirely at the taxpayer's discretion). Therefore, a constructive trust in the wife's favour over 40.5 A shares arose when they were purchased because she was entitled to half of 85 A shares (i.e. 42.5 shares) but in fact received only 2 A shares and a promise of almost valueless B shares. Those 40.5 shares were held in law by the taxpayer but on trust for his wife. Therefore, when the taxpayer caused the company to allot the 10 B shares to his wife, although the arrangement was not commercial, it was not gratuitous either. It was a recognition, albeit a very inadequate one, of her rights to shares in the company. There was no bounty. He owed her more than 10 B shares. If he had transferred to her 40 of his A shares it would not have been gratuitous as she was entitled to them: the allotment instead of the (almost valueless) B shares could not therefore be gratuitous (Jones v Garnett applied; Bird distinguished). In all the circumstances, the B shares were not settled by the taxpayer on his wife within the meaning of s. 660A.
The question then arose whether the B dividends were settled on the wife. A decision by the controlling shareholder to only issue a dividend on one class of shares rather than another (B shares in this case in preference to A shares) could be an arrangement caught by s. 660A. That followed generally from the expansive wording of Income and Corporation Taxes Act 1988 section 660G subsec-or-para 1s. 660G(1) to include "arrangement" and the need to take a broad and realistic view of the arrangements. However, as with the allotment of the shares themselves, s. 660A only applied where the arrangement involved gratuity. The arrangement in this case was not a commercial arrangement: but the lack of commerciality was on both sides. In causing his wife to be paid dividends (albeit on the B shares) the taxpayer was paying her dividends to which she was at least in part entitled. To the extent that she was entitled to the dividends, there was no gratuity and therefore no settlement within s. 660A. If and to the extent that the dividends she was paid exceeded her entitlement as the beneficial owner of 42.5 of the A shares, there was a settlement within s. 660A. Furthermore, the B dividends would not be excepted from s. 660A on the grounds that they were outright gifts because s. 660A(6)(b) provided that the exception did not apply where the property given was wholly or substantially a right to income. Dividends were income (Buck v R & C CommrsSCD(2008) Sp C 716 considered).
In any event, even if it were not for the exception against gifts of income in Income and Corporation Taxes Act 1988 section 660A subsec-or-para 6s. 660A(6), the settlement (to the extent there was one) could not, any more than the alleged gift of the B shares themselves, be an outright gift because the last exception in that subsection applied. The arrangement was that the dividend income would be used by the wife to discharge the mortgage on which both she and the taxpayer were liable and not for any other purpose. The property given would therefore become applicable for the benefit of the donor.
1. Mr Patmore appeals against amendments to his tax returns as follows:
Year 1999/00 increase in tax due of 4,749.97
Year 2000/01 increase in tax due of 4,999.95
Year 2001/02 increase in tax due of 4,875.07
Year 2002/03 increase in tax due of 5,124.82
2. The amendments were made by HMRC to bring into account dividend income of 21,111 paid in the year 1999/00, 22,222 in year 2000/01, 21,666 in year 2001/02 and 22,777 in the year 2002/03 which was paid to Mrs Patmore, the Appellant's wife. HMRC considered that this income was properly taxable on Mr Patmore as income arising under a settlement within the meaning of Income and Corporation Taxes Act 1988 section 660As. 660AIncome and Corporation Taxes Act 1988 ("ICTA").
3. Oral evidence at the hearing was given by Mr and Mrs Patmore and their accountant Mr McMorran who was the architect of the arrangements the subject of the appeal.
4. The documentary evidence of what happened included:
The share sale agreement;
Company accounts and annual returns;
Minutes of "company" meetings
Dividend vouchers
A document headed "underlying philosophy"
5. I find the facts to be as follows:
6. Cambridge Dynamics Ltd ("the Company") was incorporated on 17 August 1978 and traded as an engineering business. The founder, managing director and major shareholder of the company was a Mr M Henson. Mr Patmore, the Appellant in this case, joined the company as an employee shortly after it was founded and later became a director. In 2000 the Company had an issued share capital of 100 shares. 75 were owned by Mr Henson, 8 by his wife, and 1 each by his two children. The remaining 15 were owned by Mr Patmore.
7. In 1998 Mr Henson indicated he wished to retire and sell his business. After protracted negotiations, a share sale agreement was entered into on 14 January 2000. The vendors were Mr and Mrs Henson and their two children. The purchasers were Mr and Mrs Patmore. The price was 320,000 (subject to adjustments dependant on subsequent profits). 100,000 was paid on the day of completion. 110,000 was due on 1 October 2000 and the final instalment of 110,000 was due on 1 October 2001. I refer to these two stage payments as the Henson debt. These two deferred payments carried interest. In the event, under the terms of the share purchase agreement, there were some small adjustments downwards to the two stage payments due to diminished subsequent profits: they were each in the event approximately 100,000.
8. On completion Mr and Mrs Henson transferred their...
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