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The original Settlements Legislation was passed in the 1930s and whilst it was updated as recently as the mid-1990s, it only came to the nations consciousness at the turn of this century when the Revenue, as it was then, started tackling small limited companies under what became known as “Section 660” with matters coming to a head with the Jones V Garnett or Arctic Systems Case.

Simply put, the legislation is designed to deal with situations where income arises from a gift – such as shares – given by one person to another, but as a result of the gift the donor receives a benefit.  This is known as a “bounteous” arrangement and in the example of the gift of shares which are “wholly or substantially a right to income” then the benefit to the donor would be that the gift is allowing the donor to “settle” their income on another person who pays tax at a lower marginal rate. 

A classic example is where one fee earner brings in all the income, but by dividing the profits of the business with a spouse equally via the shareholding, the overall tax burden to the household is reduced.  This had been a standard form of tax planning for small businesses over many generations, but with the Arctic Case suddenly the accountancy professionals’ approach to tax planning and HMRC’s settlements legislation were brought into sharp focus and the two opposing views collided.

Much has been written about this titanic struggle between Geoff and Dianna Jones of Arctic Systems Ltd, who with the backing of many interested parties took on HMRC (as it had now become) in a case which could have had a dramatic impact on thousands of small businesses.  The final outcome was always in doubt – both sides had lost and successfully appealed – as the case wound its long torturous route from the local tax office via the Special Commissions, the High Court and the Court of Appeal until it was finally decided in the House of Lords.

The Judgement

In summary, the Law Lords all agreed that there was a “settlement” for the purposes of S660, but rejected HMRC’s appeal on the basis that it fell within the exemption provided for an outright gift between spouses.  The settlements legislation therefore does not apply to companies jointly owned by married couples and civil partners and structured in this way. 

The Law Lords did however judge that this only applied to ordinary shares and that preference shares would, however, most likely be considered as wholly and substantially a right to income, and not exempted from the settlements legislation, irrespective of whether or not the settlor and settlee are married.  Indeed, we are aware that HMRC are actively pursuing enquiries into arrangements involving preference shares.

The Government’s Response

It was swift coming the day after the judgement.  It acknowledged that the Settlements Legislation was not sufficient to deal with this particular issue and announced that the Government would be legislating on “Income Shifting” following a consultation exercise.  This Consultation Paper called “A Guide to Income Shifting” was issued on 6th December 2007 and sought responses from interested parties by 28th February 2008. To date, no further action has been taken but you can read our summary of the content in our section on ‘income shifting‘.

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