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In from the cold
The Arctic Systems appeal has been decided in favour of the taxpayer. To reiterate the facts of the case briefly, the taxpayer and his wife each owned one share in a company which earned profits by providing the taxpayer's services to clients. He took a small salary with the profits of the company being distributed as dividends equally between the taxpayer and his wife. HMRC said that this arrangement was within the settlements legislation, i.e. TA 1988, s 660A, (now ITTOIA 2005, ss 624 and 625) with the taxpayer being the settlor. The dividends paid to the wife were therefore taxable as part of the husband's income.
The Special Commissioners dismissed the taxpayer's appeal, as did the High Court (see 'Arctic Blast', Update, Taxation, 5 May 2005, page 120). However, the Court of Appeal has allowed the taxpayer's appeal, ruling that the dividends paid to the taxpayer's wife were not within s 660A. The lead judgment, given by the Chancellor of the High Court, Sir Andrew Morritt, concluded that there was no settlement, distinguishing the Hawkins case on the grounds that the contract to work for a low fee was already in place in that case before the shares were transferred. If the s 660A(6) issue had been relevant, the Chancellor would have held that there was no outright gift, although he did not accept that the gift was wholly or mainly one of income. The whole issue of what constituted an outright gift concerned Carnwath LJ, who felt that the legislation was not clear, and all three judges felt that the attempted extension of the existing principles by the Revenue in this case was a step too far, especially considering that independent taxation had been introduced since the majority of the cases were decided.
Calling it a 'sensible decision', Paula Tallon, director, Chiltern, said that this was an early Christmas present for the many small family businesses in the UK, adding 'Who said there is no such thing as Santa?' Peter Penneycard, tax director, PKF, said that as the Court of Appeal has not been very receptive to taxpayers' arguments in recent cases, 'this ruling was particularly welcome'. He noted that Mr Justice Park's High Court ruling had taken a 'very broad definition of the term “settlement” and a narrow interpretation of the exemption from the settlement rules where one spouse gifts assets to another' but that Parliament, when it introduced independent taxation of husbands and wives, had never 'intended that gifts between spouses should create automatically a settlement'. Welcoming the judgment, Professional Contractors Group chairman Simon Juden, said, 'This is the best Christmas present for the UK's small family businesses. It means proper recognition for the hundreds of thousands of people who choose to run their own businesses, share the burdens and the hard work with their partners, and rightly expect to share the profits of their efforts'. He hoped that the Government would 'scrap the uncertainty, unfairness and inconsistency of legislation like this, which meant that the goalposts suddenly moved for thousands of small businesses'. In addition, Dr Juden thanked all of those who have generously supported this case: James Kessler QC, PCG members, Berg Kaprow Lewis, the Federation of Small Businesses, JSA and members of the public.
The bottom line, says Mark Lee, managing director, London office, Shaw & Co is that 'the rationale for the Court of Appeal's decision in favour of the taxpayer accords with many of the points raised by the professional bodies over two years ago. Perhaps HMRC could confirm that they will give a little more credence to our questions if we approach them jointly on a future occasion?'
While the decision is excellent news for the taxpayers, HMRC does have the option to appeal. However, they will have to apply to the Lords as the Court of Appeal has refused leave to appeal.
The decision has been released in good time so that company owners can complete or amend their tax returns before the 31 January deadline. It should be noted that tax returns which have been filed online cannot be amended electronically. However, HMRC say that if a taxpayer has filed his return online and, in the light of the judgment, wishes to amend it, he can write to HMRC saying how the return is to be amended. HMRC say that there is no need to re-submit a full paper return, a letter will do.
