Jones v Garnett (Her Majesty's Inspector of Taxes)

The House of Lords considered whether arrangements by which a husband and wife used a private company to receive and distribute income gave rise to a "settlement" for the purposes of Chapter IA of Part XV of the Income and Corporation Taxes Act 1988 (in particular sections 660A and 660G) and, if so, whether an exception for an "outright gift" in section 660A(6) applied. The court took a broad, realistic view of "arrangement" and concluded that the transfer of a subscriber share to Mrs Jones, together with the contemporaneous intention that income would be distributed by low salaries and dividends, did constitute an arrangement involving an element of "bounty". However, the court held that the share transferred was an ordinary share and not "wholly or substantially a right to income"; accordingly the transfer fell within the section 660A(6) exception and the anti-avoidance charge did not apply. The appeal by the Revenue was dismissed.

This was an appeal by the inspector of taxes against the taxpayer couple, Mr and Mrs Jones. After redundancy Mr Jones and his wife acquired a shelf company (Arctic Systems Ltd). Mr Jones acted as the principal fee-earning consultant; Mrs Jones provided back-office services (bookkeeping, bank, insurance, correspondence) for a few hours a week. On the accountant's advice they agreed to low salaries and to distribute the remainder of company receipts as dividends, to take advantage of lower National Insurance and lower tax rates on the wife's income. The Revenue contended that the arrangement amounted to a "settlement" under Chapter IA of Part XV of the Income and Corporation Taxes Act 1988 and that, because Mr Jones was a settlor retaining an interest, the dividends paid to Mrs Jones should be treated as his income under section 660A.

The principal issues before the House were (i) whether the share transfer and associated plan were a "settlement"/"arrangement" for the purposes of sections 660A and 660G (the element of "bounty" question), and (ii) whether, if there was a settlement, the transfer was nonetheless an "outright gift" excluded by section 660A(6) (including whether the share was "wholly or substantially a right to income").

The court reviewed authorities on the breadth of the statutory definition of "settlement" and the concept of "bounty" (including Crossland v Hawkins, Butler v Wildin, Payne and others). It concluded that a realistic, purposive approach applied: where the parties intended at the time of creating the vehicle that income would be channelled so as to benefit the spouse, the necessary unity exists and an element of bounty may be present, so there was a settlement. On the second issue the court held that an ordinary share confers rights beyond merely a right to income (voting, participation on winding up, other rights under the articles) and so is not "wholly or substantially a right to income"; therefore the transfer was an outright gift within section 660A(6) and fell within the exception. The House accordingly dismissed the Revenue's appeal.

• Nature of claim: tax appeal seeking to treat dividends as the settlor's income under s.660A (anti-avoidance).
• Issues framed: (i) whether an arrangement/settlement existed (s.660G/660A); (ii) whether the transfer was an "outright gift" excluded by s.660A(6), including the characterisation of ordinary shares.
• Court's reasoning: adopted a broad purposive approach to "arrangement" and "bounty"; accepted that expectations of future events can impart value and form part of an arrangement; but held ordinary shares are not substantially a right to income and so attract the s.660A(6) exception.

Appeal dismissed. The Lords held that the creation of the company and the contemporaneous agreement to use low salaries and dividends constituted an arrangement/settlement for the purposes of sections 660A and 660G (an element of "bounty" existed), but that the share transferred to Mrs Jones was an ordinary share and not "wholly or substantially a right to income"; therefore the transfer fell within the "outright gift" exception in section 660A(6) and the anti-avoidance charge did not apply.

The case began before the commissioners (there were conflicting findings of the senior and junior general commissioners). Park J (High Court) accepted the Revenue's case. The Court of Appeal ([2005] EWCA Civ 1553; reported [2006] 1 WLR 1123) reversed on the arrangement point. The House of Lords ([2007] UKHL 35) heard the appeal from the Court of Appeal and dismissed the Revenue's appeal.