Arctic Systems: Result and fall-out

Posted: October 3, 2007

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Introduction
At the end of his judgment in the case of Jones v. Garnett  Park, J., said, ‘I have given judgment at some length because there is widespread professional interest in this case, but I do not think that there is anything particularly novel or alarming in my decision. I believe that it is a simple application of well-established principles. Applying those principles, I dismiss the appeal.’
Having come, with both his brother judges, to exactly the opposite conclusion, at the end of his judgment in the Court of Appeal Carnwath, L.J., said, ‘The lack of a clearly ascertainable legislative purpose underlines the need for caution in extending the concept of settlement beyond the scope of existing jurisprudence. The revenue’s position in this case seems to me a significant extension.’
So clear were the judges in the Court of Appeal that their conclusion was the right one that they refused leave to appeal. So doubtful were the Appeal Committee of the House of Lords that they granted leave to appeal.
The House of Lords has now given its decision, five nil in favour of the taxpayer overall, but entirely against him on one of the two issues that arose.  The Government’s response is that it will now consider legislation, presumably to reverse some of the effects of the decision. But it appears that there is no political will for more fundamental reform of the tax system as it affects either married couples  or small businesses.
 
II. The legislation
For the purposes of the case, the relevant legislation is contained in the Income and Corporation Taxes Act 1988 (‘the 1988 Act’), as in force for tax year 1999 / 2000.  Section 660A of the 1988 Act provided inter alia:
‘(1) Income arising under a settlement during the life of a settlor shall be treated for all purposes of the Income Tax Acts as the income of the settlor and not as the income of any other person unless the income arises from property in which the settlor has no interest.’
The basic device this seeks to prevent is a person putting assets into trust in order to avoid paying tax on the income those assets produce.
The provision continued:
‘(2) Subject to the following provisions of this section, a settlor shall be regarded as having an interest in property if that property or any derived property is, or will or may become, payable to or applicable for the benefit of the settlor or his spouse in any circumstances whatsoever.’
So if I establish a trust and make my wife  a beneficiary, I shall be deemed to have an interest in the trust property and the trust income shall be treated as if it is mine.
There was an important exception:
‘(6) The reference in subsection (1) above to a settlement does not include an outright gift by one spouse to the other of property from which income arises, unless—
(a) the gift does not carry a right to the whole of the income, or
(b) the property given is wholly or substantially a right to income.
For this purpose a gift is not an outright gift if it is subject to conditions, or if the property given or any derived property is or will or may become, in any circumstances whatsoever, payable to or applicable for the benefit of the donor.’
So, one can give an income-producing asset (for example, shares) to one’s spouse, with the effect that the income from it is taxed in the hands of the spouse; but if what one gives is merely the right to income (for example by assigning one’s right to dividends) one does not escape the effect of the settlements legislation. The income is still taxed as if there had been no assignation.
One might ask how it comes about that a settlement might be thought to include an outright gift to a spouse: the structure suggested by the word ‘settlement’ is that of a trust.  However, in this context ‘settlement’ has an extended meaning. Section 660G of the 1988 Act provides:
‘(1) In this Chapter—
“settlement” includes any disposition, trust, covenant, agreement, arrangement or transfer of assets, and
“settlor”, in relation to a settlement, means any person by whom the settlement was made.’
The courts having held that the particular examples of transactions identified in the definition of ‘settlement’ are not to be restricted in scope to things that are of the nature of a settlement.  So the concept of a ‘settlement’ is much broader than that of trust, and includes a straightforward gift. Were it not for the exception for gifts to spouses, if I gave my wife some shares I would have to pay tax on the dividend income she received as if it were mine.
It may be mentioned at this stage that because of the breadth of the definition of the term ‘settlement’, and despite indications in early cases,  the courts have found it necessary to set up some criterion to restrict the scope of the provisions. Otherwise, they would cover a large number, if not almost all, ordinary commercial transactions.  Having held that they could not achieve this aim by restricting the meaning of the types of transactions identified,  or by reading in an exception for bona fide commercial transactions,  they have elected for the criterion of ‘bounty’.  The meaning of this criterion in turn was one of the main issues raised in Jones v. Garnett.

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