The House of Lords held that an arrangement by which one spouse used a private company as a tax-efficient vehicle for distributing to the other income which its business generated was likely to constitute a ‘settlement’ on the other spouse within ICTA 1988, s. 660G(1). But so long as the shares from which that income arose were ordinary shares, not carrying contractual rights restricted wholly or substantially to a right to income, the settlement would fall within the exception created by s. 660A(6) as an outright gift.

Facts

The taxpayer, who worked in the field of information technology, provided his services through a company which he jointly owned with his wife. As the shareholders of the company the taxpayer and his wife agreed that the company would pay them salaries which would meet their basic needs and that any profits would be distributed as dividends. It was the taxpayer as director who decided whether to declare the dividends.

The Revenue took the view that the dividends were income arising from a settlement, comprising the wife's share in the company, within the meaning of ICTA 1988, s. 660G and that that income should be treated as the income of the taxpayer as settlor of that settlement as a result of s. 660A(1). The taxpayer appealed against assessments for the years 1996-97, 1997-98 and 1998-99 on the ground that the dividends were not income arising from a settlement of which the taxpayer was settlor. The special commissioners dismissed the taxpayer's appeal, agreeing with the Revenue that the settlement provisions applied and that the exclusion for outright gifts by one spouse to another in ICTA 1988, s. 660A(6) did not apply ((2004) Sp C 432).

The taxpayer appealed contending that the corporate structure was not an arrangement, but, even if it was, it fell within the outright gift exclusion in s. 660A(6) and was excluded from the description of a settlement.

The Revenue argued that the corporate structure whereby the taxpayer was responsible for earning all the income of the company, from which he drew only very small remuneration but which paid substantial dividends, half of which went to the wife on her 50 per cent interest in the company, was an ‘arrangement’ within s. 660G(1) and therefore ranked as a settlement for the purposes of s. 660A.

The High Court dismissed the appeal, holding that, since the structure of the company was an 'arrangement' within s. 660G(1), it ranked as a ‘settlement’ for the purposes of s. 660A and s. 660A(6) did not apply to exclude the arrangements as being an ‘outright gift’ by the husband to the wife ([2005] BTC 306).

The Court of Appeal allowed the taxpayer's appeal, finding against the Revenue on the arrangement issue, although it would have ruled in favour of the Revenue on the outright gift issue ([2006] BTC 24).

Issues

Whether there was a settlement within the statutory definition in s. 660G(1); and if so, whether there had been an outright gift by the husband to the wife within s. 660A(6) so as to be excluded from the operation of s. 660A(1).

Decision

Lord Hoffmann (Lord Hope, Lord Walker, Baroness Hale and Lord Neuberger delivering concurring opinions) (dismissing the appeal) said that not every transfer of property was a settlement for the purposes of s. 660A. There had to be an ‘element of bounty’ in the transaction. That old-fashioned phrase, apparently derived from the judgment of Plowman J in IR. Commrs v Leiner (1964) 41 TC 589 and approved by the House of Lords in IR Commrs v Plummer [1980] AC 896 was not the happiest way of describing a provision for a spouse or minor children. A donation to a spouse or child was traditionally expressed in a deed to be ‘in consideration of natural love and affection’ rather than the donor's bounty. It was nevertheless exactly the kind of thing at which the anti-avoidance provisions were aimed. In Chinn v Hochstrasser (1980) 54 TC 311, Lord Roskill cautioned against treating the word 'bounty' as if it had been included in the statute. The general effect of the cases was that, under the arrangement, the settlor must provide a benefit which would not have been provided in a transaction at arms' length.

In the present case, taking a broad and realistic view of the matter, the arrangement had the necessary element of bounty. The wife could not have been issued with a share without the agreement of the taxpayer 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 the taxpayer should, in a broad sense, transfer some of his earnings to his wife.

This was not a ‘normal commercial transaction between two adults’. It made sense only on the basis that the two adults were married to each other. If the wife had been a stranger offering her services as a book keeper, it would have been a most abnormal transaction. It would not have been an arrangement into which the taxpayer would ever have entered with someone with whom he was dealing at arms' length. It was only 'natural love and affection' which provided the consideration for the benefit he intended to confer upon his wife. That was sufficient to provide the necessary 'element of bounty' (Crossland (HMIT) v Hawkins (1961) 39 TC 493 and Butler (HMIT) v Wildin [1988] BTC 475 considered).

However, the arrangement came within s. 660A(6) which created an exception for cases in which one spouse made an 'outright gift' to the other of the property from which the income arose. Thus a gratuitous transfer of quoted shares from husband to wife, although obviously a settlement for the purposes of s. 660A, was excluded from the section and the income was taxed as the wife's income. That applied equally to the transfer to the taxpayer's wife of her share in the company from which her dividend income arose. The Revenue had contended that the exception did not apply in the present case since there was no gift of the share by the taxpayer to his wife: he never owned the share which she took; and it belonged to the formation agents and the wife bought it from them for £1.

That narrow analysis of the transaction would be inconsistent with the reasoning by which the transfer came within s. 660A in the first place. It was the taxpayer's consent to the transfer of a share with expectations of dividend to his wife for £1 which gave the transfer the 'element of bounty' for the purposes of s. 660A. By the same token, it made the transfer a 'gift' for the purposes of s. 660A(6). And there was no dispute that, if it was a gift, it was outright. The transfer of the share was the essence of the arrangement. The expectation of other future events gave that transfer the necessary element of bounty but the events themselves did not form part of the arrangement.

Finally, the share was not wholly or even substantially a right to income. It was an ordinary share conferring a right to vote, to participate in the distribution of assets on a winding up, to block a special resolution, to complain under s. 459 of CA 1985. Those were all rights over and above the right to income. The ordinary share was different from the preference shares in Young (HMIT) v Pearce [1996] BTC 322, which conferred nothing except the right to 30 per cent of the net profits before distribution of any other dividend and repayment on winding up of the nominal amount subscribed for their shares. Those shares were substantially a right to share in the income of the company. In all the circumstances, the arrangement fell within the exception in s. 660A(6).

House of Lords.
Judgment delivered 25 July 2007.