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The House of Lords delivered their judgment in the case of Jones v Garnett [2007] UKHL 35 (aka Arctic Systems) on 25 July 2007, finding in favour of the taxpayer. The Lords held that the arrangement whereby Mrs Jones held one of the two shares issued in respect of the company through which her husband carried on his consultancy business was a settlement, but that the income therefrom would not be treated as that of Mr Jones because the exemption for an 'outright gift' in TA 1988, s 660A(6) applied.
The fact that HM Treasury issued an immediate response might lead one to suspect that they thought that the writing was on the wall, perhaps no surprise after their defeat in the Court of Appeal.
The view of the Institute of Directors was that 'tax can rightly be saved when a company is split between working spouses. This is clearly in accordance with the legislation. A lot of small businesses up and down the country will be mightily relieved. … At last, after four years, the worry is over for many small businesses. And I hope that the Revenue will no longer push the law where it was not meant to go'.
Paula Tallon of Chiltern plc suggested that 'the Chancellor would be ill advised to impose further tax on Middle England at this time'.
Berg Kaprow Lewis flagged up some initial concerns, stating that 'some of the comments being made in the light of the Arctic decision are worrying. HMRC's counsel for example, is reported as saying that "The scheme in this case takes advantage of a loophole”'. BKL express surprise — no doubt in common with all of those practitioners who have suggested such a corporate structure over the years without prior challenge from HMRC — that this should now be regarded as a 'loophole'. They suggest that practitioners should 'make their representations as widely and as forcefully as possible'. That time might be short is indicated by the written Ministerial statement by the Exchequer Secretary to the Treasury, Angela Eagle, who announced the Government's intention to legislate the day after the judgment.
The ministerial statement
'The Government acknowledges the judgment given by the House of Lords in the Jones v Garnett (“Arctic Systems”) case.
'The Government is committed to maintaining fairness in the tax system. The case has brought to light the need for the Government to ensure that there is greater clarity in the law regarding its position on the tax treatment of “income splitting”.
'Some individuals use non-commercial arrangements (arrangements that they would not reasonably enter into with an arm's length third party) to divert income (which would, in the absence of those arrangements, have flowed to them) to others. That minimises their tax liability, and results in an unfair outcome, increasing the tax burden on other taxpayers and putting businesses that compete with these individuals at a competitive disadvantage.
'It is the Government's view that individuals involved in these arrangements should pay tax on what is, in substance, their own income and that the legislation should clearly provide for this. The Government will therefore bring forward proposals for changes to legislation to ensure this is the case. In the meantime, HMRC will apply the law as elucidated by the House of Lords and will be providing guidance in due course.
'The Government would not want commercial arrangements to be caught by any change to legislation. Consultation should help to ensure this.'
Innocence and experience
Andy Wells of Mercury Tax Group described Ms Eagles' statement as 'mean' and thinks that 'the Minister does not understand the case if she really considers that the Jones' arrangements were unfair to other taxpayers. 'It feels like the reaction of a spoiled child that hasn't got its own way. Also it is disingenuous to say that "the case has brought to light the need for the Government to ensure that there is greater clarity in the law”. It was HMRC that misunderstood the law and it is insulting to the House of Lords as well as to the tax profession, to suggest that changes will be made in the name of clarity.'
BKL suggest that others might come to the conclusion that Ms Eagle's lack of practical business experience might not make her the best person to understand how entrepreneurs operate. We would agree with them that such an observation would be 'churlish, small-minded and unworthy'.
The professional view
The CIOT and Tax Faculty have issued a joint statement on the decision and the ministerial statement. This notes that 'the Government announced a review of small business taxation in 2004 and it would be much better to await the outcome of this review rather than rush through legislation. There have been too many cases in the recent past where legislation introduced without proper consideration and consultation has ended up creating more problems than it solves'.
Andrew Hubbard, CIOT Vice-President, said that, whilst the Government has the right to decide who should pay tax, 'the Ministerial statement published today will almost certainly lead to yet more complex tax legislation to deal with the situation that Mr and Mrs Jones faced. Given the new Chancellor's stated commitment to making the tax system simpler, this would be a backward step'.
Francesca Lagerberg, Chairman of the Technical Committee of the ICAEW Tax Faculty, says: 'The Government is looking to review situations where family members are involved together in a business. It appears that the tax authorities will seek to separate out “commercial” situations from those where it believes dividends are being passed to lower rate taxpayers primarily to keep down the tax bill. The reality is that most businesses do not fall into such neat categories. There is a danger that rushed legislation will result in unworkable legislation, plunging thousands of taxpayers into yet more uncertainty about their tax position. There is now an urgent need for full and detailed consideration of the small business tax regime, which should include a detailed understanding of the businesses and the issues involved and full consultation, which should be completed before any measures are announced. A full and open debate is required, and we would welcome a review that covered all aspects of this area without leaving hardworking individuals like Mr and Mrs Jones with years of concern about their future tax liabilities'.
Your view
Mike Truman summarises the decision of the House of Lords in this issue ('Geoff Jones and the lost Garnet(t)') and Francesca Lagerberg will be giving us her opinion next week. These articles — and future articles on this subject — will be linked together on the 'Arctic Systems' page on the Taxation website and we would be happy to receive your views which can be submitted via the 'Discussion' link at the foot of that page. Please note that responses do not appear immediately; they are checked first by the editorial team, but they should appear within 24 hours.
