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

The settlements provisions may apply where one spouse acquires an interest in a company through which the other spouse’s services generate income. An arrangement contains the required element of bounty where it confers a benefit that would not have been provided at arm’s length. Expected future conduct and income may be considered even though they are not contractually assured.

However, the spouse exemption in section 660A(6) of the Income and Corporation Taxes Act 1988 applies where the arrangement amounts to an outright gift of an ordinary share. An ordinary share is not wholly or substantially a right to income because it also carries voting, capital and winding-up rights. The objective rights attached to the property, rather than the donor’s purpose or its current yield, determine whether the exception applies.

Mr and Mrs Jones each acquired one £1 ordinary share in Arctic Systems Ltd. Mr Jones provided the computer consultancy services that generated its income. Mrs Jones provided limited administrative support. Both received modest salaries, and the remaining profits were distributed as dividends. The Revenue contended that the arrangements were a settlement under sections 660A and 660G of the Income and Corporation Taxes Act 1988, so that Mrs Jones’s dividends should be treated as Mr Jones’s income.

The General Commissioners divided. Park J found for the Revenue: [2005] EWHC Ch 849; [2005] STC 1667. The Court of Appeal allowed the taxpayers’ appeal because it found no sufficient element of bounty, although it would otherwise have rejected the outright-gift exemption: [2005] EWCA Civ 1553; [2006] 1 WLR 1123.

The issues before the House were whether the corporate arrangements constituted a settlement and, if so, whether Mrs Jones’s share fell within the exception for an outright gift between spouses.

1. The Revenue’s appeal was dismissed unanimously. The House agreed that the arrangements constituted a settlement, but held that the acquisition of Mrs Jones’s ordinary share was protected by the outright-gift exception in section 660A(6) of the Income and Corporation Taxes Act 1988.

2. Per Lord Hoffmann, Lord Hope, Lord Walker and Lord Neuberger, the statutory definition of settlement is qualified by the requirement for an element of bounty. That requirement is satisfied where the settlor provides a benefit which would not have been provided in an arm’s-length transaction. Mr Jones would not have enabled an unrelated bookkeeper, providing comparable services, to acquire half the company’s equity for £1 with an expectation of substantial dividends. His consent therefore conferred the necessary gratuitous benefit.

3. Per Lord Hoffmann, Lord Walker and Lord Neuberger, the arrangement had to be viewed broadly and realistically. When the company and its share structure were established, the parties intended that Mr Jones would work for a low salary and that profits would be distributed equally as dividends. The absence of a binding service contract and the commercial contingencies affecting future profits did not prevent the arrangement from possessing sufficient unity. Subsequent work and dividends were the intended use of the corporate structure and the means by which income arose under it; they were not themselves necessary components of the settlement.

4. Per Lord Hoffmann, Lord Walker and Lord Neuberger, Mrs Jones’s purchase for £1 could constitute a gift. The same expected future conduct that supplied the element of bounty gave the share a value exceeding its nominal price. The bounty could not be detached from the property when applying section 660A(6). The acquisition was unconditional and outright.

5. Per Lord Hoffmann, Lord Hope, Lord Walker and Lord Neuberger, the ordinary share was not wholly or substantially a right to income within section 660A(6)(b). It also carried voting rights, rights to capital and surplus assets on winding up, and other membership rights. The inquiry concerns the objective rights attached to the asset, rather than the reason for acquiring it, the company’s assets at the time, or the income expected from it. Ordinary shares therefore attract the exception, unlike preference shares whose rights are substantially confined to income.

6. Baroness Hale agreed that the appeal should be dismissed and that section 660A(6) applied. She expressed reservations about treating the initial arrangement as a settlement, but did not dissent from the House’s conclusion on that issue.

1. House of Lords: The Revenue’s appeal was dismissed unanimously. The Court of Appeal’s order in favour of the taxpayers was upheld, although for different reasons: [2007] UKHL 35.
2. Court of Appeal: The taxpayers’ appeal was allowed because the court held that the arrangements lacked the necessary element of bounty. It would otherwise have held that the outright-gift exception was unavailable: [2005] EWCA Civ 1553; [2006] 1 WLR 1123.
3. High Court: Park J held for the Revenue on both the settlement and outright-gift issues: [2005] EWHC Ch 849; [2005] STC 1667.
4. General Commissioners: The senior commissioner found for the Revenue on both issues; the junior commissioner found for the taxpayers on both issues.