Tax & Estate Planning - A win for family business

Family owned businesses are celebrating this morning after the House of Lords unanimously dismissed HMRC’s appeal in the Arctic Systems case (Jones v Garnett (HM Inspector of Taxes)).

The presiding Lords confirmed that the company structure and income/profit arrangement relied upon by Mr and Mrs Jones constituted a statutory settlement within the meaning of section 660G of the Income and Corporation Taxes Act 1988 although that did not preclude the couple from using the available relief of outright gifts between spouses/civil partners which meant that the profit could be excluded from the settlement provisions.

Accordingly, Mrs Jones was assessable on the dividends she received from the family company even though most of the profits were generated as a result of Mr Jones’ efforts.

The Facts

The case revolves around the split and apportionment of income/profits in a husband and wife business.

Geoff and Diana Jones were the owners of IT consultancy Arctic Systems Ltd in which Mr Jones was effectively the sole fee-earner. The company had a turnover of over £90,000 and Mr Jones worked full time but drew a salary of around £7,000.

Mrs Jones spent not more than 4 hours a week dealing with the business administrative side and drew a salary of around £4,000.

After expenses and corporation tax, the couple shared the remaining £60,000 equally in dividends.

HMRC argued Mr Jones had unfairly transferred some of his income, in the form of dividends, to Mrs Jones to benefit from her lower tax status. That meant that they paid less tax and national insurance on their income because they drew most of the profits from the company as dividends at a lower rate.

HMRC relied on an aspect of the law of settlement arising from passing assets to a third party allowing them to enjoy those assets but not to control them.

The courts at first instance agreed with HMRC that Mr Jones had given away his right to receive a part of his income to his wife, effectively in a settlement, in order to obtain a tax advantage. It was determined that the £4,000 Mrs Jones was paid as a salary was fair reward for the work she did. The additional £30,000 she received in dividends was deemed to be rightfully her husband's property so that he should have been taxed on all of the dividend income, at his highest tax rate.

The Court of Appeal reversed the decision and this was backed by the decision of their Lordships this morning.

Further Advice

We will be more than happy to discuss the implications of this decision on your business and estate. Please do not hesitate to contact us for further information.

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E-mail: hed.amitai@bowlinglaw.co.uk
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Website: www.bowlinglaw.co.uk

The law and practice referred to in this bulletin are those in force on 25 July 2007.
This bulletin is written as a general guide and is not a substitute for professional advice.
You are strongly recommended to obtain specific professional advice before you take any action.