The Settlements Legislation was originally enacted in the 1930s, with subsequent amendments in the 1990s. Its primary aim was to prevent people from passing across assets and income to family members in an effort to reduce their tax liabilities, whilst intending to reclaim those assets at a later date. However, until recently, HMRC had not sought to apply the rule to company dividend payments.
In the mid-2000’s, HMRC began to assert that the Section 660 rules could be applied to dividend income received. In other words, where a limited company director has his non-fee earning spouse as a joint-shareholder, any dividends she receives from the company should be taxed as her husband’s income. Some taxpayers received tax demands amounting to tens of thousands of pounds, backdated several years.
At the time, HMRC appeared to target personal service companies, particularly one-man-bands, particularly if dividends were paid family members who were not actively involved in the running of the company, or if the amount of income generated by a husband and wife were not in proportion to the number of shares owned by each person.
The Arctic Systems Case
The ‘income shifting’ debate in recent years has taken place against the backdrop of a long-running court case between Arctic Systems (owned by a husband and wife) and HMRC, which lasted several years and has helped define Section 660A.
In the case, HMRC objected to the manner in which a married couple, Geoff and Diana Jones, remunerated themselves with a mixture of salaries and dividends, which had the effect of reducing their joint tax liability.
The couple spent over five years battling the Revenue’s efforts to reinterpret the law retrospectively and mount a tax raid on companies that are jointly owned by one revenue-earning partner and one non-earning partner.
The Joneses arranged their affairs so that in 2000/2001, Mr Jones paid himself a £7,000 salary and his wife received almost £4,000, from the £91,000 turnover. After expenses and corporation tax, the couple shared the remaining £60,000 equally in dividends.
HMRC, which won a tax tribunal and High Court ruling but lost an appeal by the Joneses to the Court of Appeal in 2005, had argued that Mr Jones had not drawn an adequate salary and because he was solely responsible for the income generated by the couples’ company, he should have received a greater share of the profits. Being a higher-rate taxpayer than Mrs Jones, it claimed he would then have been subject to tax at a higher rate.
In 2007, The House of Lords ruled in favour of Geoff and Diana Jones.
PCG (formerly the Professional Contractors Group), which represents contractors and freelancers, supported Geoff and Diana Jones in their House of Lords appeal and stated that the total cost of the case was likely to be in excess of £500,000.
Costs were awarded against HMRC at the hearing in 2007, which means that the UK taxpayer had to foot the bill.
The birth (and delay) of additional ‘income shifting’ measures
Not soon after the Arctic Systems defeat, HMRC swiftly announced its intention to clamp down on income shifting, despite the Arctic Systems defeat.
The following text was extracted from the 2007 Pre-Budget Report (Chapter 5 of the publication, “Fairness and Opportunity for All”):
5.99 The Government believes it is unfair that some individuals arrange to gain a tax advantage by shifting part of their income, from dividends or another person who is subject to a lower rate of tax.
5.100 The Government will be launching a consultation shortly on prevent such income shifting, with the intention that this legislation 2008-09. The Government aims to ensure, through consultation, that intended to reduce tax, rather than commercial arrangements, are affected and that the administrative burdens of the legislation are minimised.
However, plans to implement any new income shifting measures were delayed in Budget 2008, and then postponed indefinitely in the November 2008 Pre-budget report.
In a December 2010 interview, the head of the newly-formed Office of Tax Simplification mentioned that income shifting may be addressed again in the future, however, no new initiatives have surfaced in the six years since the 2007 House of Lords decision.
