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Arctic Systems – Final day at the Lords

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6th Jun 2007
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Nichola Ross Martin AccountingWEB tax editor, Nichola Ross Martin writes: Although scheduled for a three day hearing, the case of Jones v. Garnett came to a close at the House of Lords by lunch time on day two. We had left Mr Malcolm Gammie QC defending Mr Jones’s corner on the previous day, and so he continued to put his argument forward.

It is worth re-capping on the highlights of yesterday, central to these is the idea that a settlement can only be a settlement if you can find some bounty, and that you must be able to look at the arrangements to find sufficient unity to be able to describe it as a settlement. Mr Gammie argued that bounty describes the character or nature of the arrangement, and is not a separate constituent. However, if an arrangement is not a settlement, because it is not caught by this legislation then bounty is not an issue. Think about it: If Mr and Mrs Jones divorced, there would be no settlement as they are no longer spouses, and no one would worry about their dividends. The point made re-echoed that of Sir Andrew Morritt in the Court of Appeal, unity does not seem to exist where there is the facility to vary or make different decisions in future years. What if the couple were unmarried when they set up Arctic, and then married later, would dividends then paid be part of a settlement?

Mr Gammie sought to distinguish the case of Butler v Wildin (see yesterday’s report) by suggesting that not all the children in that particular case were beneficiaries of the settlement (there were a further two children), and that whilst couples in business tend to have a correlative obligation to work or at least help each other, children do not. It is hard to measure the contribution of each spouse in a business such as Arctic’.

Along the way was a quick mention of CIR v. Mills, the settlement case in which Hayley Mills the actress was found to be both settlor and beneficiary of her settlement, perhaps this was flagged up to demonstrate how the legislation works in mysterious ways.

The gift
The gift, if there was one or not was the surprise of the day. How can there be a gift when Mrs Jones subscribed to her own share? You cannot have an exemption under s 660A(6) without a gift of property. You can though have a settlement without property (it is possible with a covenant) and so the question is whether this was a settlement which had no property. This was the first argument applied yesterday by Mr Michael Furness, and actually the last as it happens too, however back to Mr Gammie, who was able to get round this by first saying that there had to be property as this is where the income derived (the dividend income, which is assessed on Mr Jones, and came from property comprising of a share) and then wheeling in a case that seems to have been overlooked: Young v Pearce [1996] 70 TC 331.

Young v Pearce or its co-joined case Young v Scrutton does not seemed to have featured very highly in any of the hearings in Arctic. The reason for this appears to be that it deals with a scheme to re-jig a company’s share capital so that husbands retained ordinary shares and their wives obtained preference shares. This scheme was deemed a settlement and the gift exemption failed because the prefs’ contained only rights to dividends and carried no other rights. I failed to note along the way that the wives had been allotted their shares, they had not been allotted first to husbands and then gifted to the wives.

Vinelott J. who was hearing the case made the observation that basically it did not matter how the wives acquired their shares, they were deemed a gift because they were in theory worth more than the £1 each paid for them as the company was already trading. Clearly you would not value them as the ordinary shares allotted at the same time, the prefs entitled their owners to share in future profits, and that was not guaranteed. Valuation was not discussed, but Vinelott J. found that there was a gift (of whatever size) as the shares were deemed to be potentially worth more than £1. Cutting to back to Arctic, the exemption in (6) should cover the gift of property as we have a similar situation where Mrs Jones purchased her own property - but this time an ordinary share. This has to be what the draftsman intended and follows Vinelott J.'s approach.

Mr Furness came back to give his reply to Mr Gammie and did not really add much more; covering the old arguments that there was not a gift in this case and if there was it was not outright, although there was a plan and this added value. “Without a plan there is no gift”. Discussion then moved onto when HMRC started to apply this legislation to spouses and the only certain-ish dates that could be divined were that the Trusts, Settlements and Estates Manual had a paragraph added on this topic in around 2000 or 2001(HMRC not sure which), this was the official intimation to the world at large of what was afoot.

The grand scheme of things
As their lordships pointed out at various times, you can get some strange results with this legislation, Arctic Systems is no more really than an incorporated partnership, and it is madness that Mr Jones could have set up the company and then gifted shares without any problems, but found that setting it up with his wife caught him up in the strange world of settlements. HMRC’s case as put forward is to possibly stretch already very wide ranging provisions so that they bite some people and not others, with little logic. Lord Hope of Craighead, gave me my quote of the day when he exclaimed during the hearing “Where does one escape from this?” I hope that the Lady and their Lordships will provide us with that answer in the next few weeks when they hand down their judgment. What that will be is anyone’s guess and but we are quietly confident that it will fall in favour of the taxpayer.

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By Paul Soper
06th Jun 2007 16:45

Good news?
I thought I would go down this afternnon (weds 6th) to hear part of the deliberations and arrived just after lunch to discover - that it was all over! I did speak to the attendant who was tidying up committee room one and he expressed the opinion that he couldn't see how the revenue could win - well in logic that is he quickly added. Now bearing in mind that he must listen to more deliberations of their lordships than their lordships this might be good news from the changing room, so to speak. Apparently, according to my same reliable source, we shouldn't expect the verdict for 6 weeks - although by that time their lordships will probably be on holiday so '13 weeks is more like it ' I replied. Has William Hill opened a book yet?

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By dgwsoft
06th Jun 2007 18:04

questions still to be asked
I was going to pop along tomorrow - well that has saved me some fees then. Enough for a bottle of the fizzy stuff when the result comes in, I hope :-)

Nice to see Young v Pearce being given more weight too. This is what I wrote to the tax man in 2003 concerning my own (very similar) case, which is on hold pending this judgement :

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Your position seems to be that there is an "element of bounty" sufficient to create a settlement, but not enough to create a "gift" in Section 660A(6). I think this is called "having your cake and eating it" and I see no reason to believe any court would take such a selective view of the legislation.

Indeed this seems to contradict the view taken by Vinelott J in Young v Pearce: "If the creation and allotment of the preference shares constituted a settlement, the subject matter of which was the preference shares allotted to the wife of each of the taxpayers, it must follow that the allotment of the preference shares taken by each wife was an outright gift from which income (the dividends paid on the preference shares) arose".

The fact that the shares created and allotted had never been held by the husbands did not prevent them being a "gift". Of course in this case, it was held that the preference shares were, as a matter of fact, "wholly or substantially a right to income", but there was no suggestion that 660A(6) was not applicable.

I refer you also to the subsequent passage in Young v Pearce, showing that this conclusion depended upon the shares being preference shares rather than ordinary shares. We maintain that ordinary shares consist of a bundle of rights, and are not wholly or substantially a right to income.

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When this case is over I hope there will be a lot more questions asked about what on earth the Revenue thought it was playing at.

Instead of making their novel interpretation of the settlements legislation public, and trying to collect all the 'owed' tax going forward, they chose to target a small proportion of those potentially liable, hit them with unpayable bills back-dated five years, and then, we understand, accept a bit more than the cost of representation at a commissioners hearing to go away. Meanwhile allowing the majority to continue a practice that they supposedly believed was 'losing' them hundreds of millions.

Clearly the strategy was to never have to defend such a case in court. This is the kind of tax system that would make a banana republic blush.

I want to know

* where/when was this policy concocted?

* when did ministers know about it?

* what does this say about consistency and fairness in the tax system?

* who is going to campaign for refunds for the several hundred small business men and women who, on the advice of their accountants, paid up under this pressure?

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Richard Murphy
By Richard Murphy
08th Jun 2007 13:26

Like many I hope the Revenue lose this one
They deserve to. It would be bad law if they won.

They'd have been much better off reintroducing the investment income surcharge on dividends.

Richard Murphy

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By martinfoley07
11th Jun 2007 22:00

win or lose....
..an aspect of greatest concern in many ways is HMRC's quite untenable stance that this is not a "test" case.

It was never a credible stance at the High Court, or the Court of Appeal.

But to lose in the manner in which they did in the CoA, be refused permission to appeal to HoL, and then still take it on and insist it is not a test case is simply unacceptable, win or lose.

That truly is a banana republic way of proceeding.

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