The case of Jones v Garnett, better known as Arctic Systems, has been in the courts now for over four years and is a case that affects thousands.

Summary of Case

The main facts of the case are that the business is owned by Mr and Mrs Jones and is run through a limited company.  They each drew small salaries with the majority of their income being drawn as dividends which they shared equally reflecting their share ownership.

As with many husband and wife companies Mr Jones was a higher rate taxpayer and Mrs Jones basic rate.  Mr Jones did the majority of the work in the company so H M Revenue and Customs (HMRC) argued that the dividend received by Mrs Jones was in reality income of Mr Jones and sought to claim the extra tax.  This was argued under the settlements provisions.

House of Lords Judgement

After a four year battle through the courts all five Law Lords in the House of Lords found in favour of the taxpayer.

In summary the House of Lords accepted that there was a settlement but that Mr and Mrs Jones fell under a specific exemption available for certain transfers between married couples.

As a result the success of this case mainly came down to the fact that the shares Mrs Jones owned were newly issued shares at par value as opposed to a gift of shares from Mr Jones.  In addition the Law Lords considered that any transfers were not wholly or substantially a right to income.  The shares were ordinary shares with rights such as sharing in assets on the winding up, blocking a special resolution, etc, over and above the right to a dividend if one is declared.

What Now?

As it stands HMRC will apply the law as elucidated by the House of Lords.  However, this case rested on the key facts of the Jones’s particular circumstances therefore all cases would have to be considered on the basis of the individual facts.

Fundamental differences might be where shares were gifted by one person to another or the shares are wholly or mainly a right to income, such as preference shares or non-voting ordinary shares, or there is little in the way of assets on the balance sheet.  These situations might still be challenged by HMRC.

The Bad News

Since the decision it has been announced that legislation is being considered to reverse the judgement and of course we have had some warning about this in previous Budget statements with reference to ‘tax-motivated incorporations’ and ‘paying the right amount of tax’.

Possible changes could be the removal of the spouse exemption from the settlements legislation, changes to dividend taxation or national insurance on dividends.

The Pre-Budget Report on Tuesday announced that they will be consulting on possible tax legislation in relation to this matter to take affect from the next Budget.  Therefore, if you think you may be affected by this, consideration should be given to drawing a dividend before that time if you have a reserve of profits.  It would be prudent to review your management accounts in February / March to determine the level of dividend that could be paid.

For further advice please speak to your usual contact at Albert Goodman.

Posted on 12 Oct 2007