Section 660A

'Settlements' legislation

 

In its Tax Bulletin 64 (April 2003), HMRC announced new guidance on the settlements legislation otherwise known as Section 660A. This is a body of law which seeks to prevent someone (known as the "settlor") from avoiding tax by reclassifying their income as belonging to someone else (known as the beneficiary.) The income is then taxed at the beneficiary’s lower rate although the settlor continues to benefit from it. The legislation targets spouses and also parents seeking to divert income via their dependants.

 

Using the revised (April 2003) interpretation of S660A, HMRC have been targeting businesses set up by spouses where they are aware that income is split between the spouses, and only one of them directly generates that income. In theory S660A can apply to partnerships as well as limited companies, but this has yet to be tested in the UK courts.

 

A well documented case is that of the Artic Systems Limited case (Jones v Garnett). Mr. and Mrs. Jones of Arctic Systems Limited; both held 50% of the company shares. The company had an annual turnover of approx £100,000. Mr. Jones paid himself a small salary of £7,000 for running the business on a full time basis, while his wife drew £4,000 for 4 hours of administrative work per week.

 

Mr. and Mrs. Jones then shared the remaining amount, less tax and expenses in the form of dividend payments, which allowed them to pay less tax and national insurance contributions.

 

Mrs. Jones received more in dividends to take advantage of her lower tax status. HMRC believed the dividend payments actually belonged to Mr. Jones and not his wife and should have therefore been taxed at the higher rate. The result was a tax bill of £42,000.

 

The case that had been running since 2001 was subsequently won at the Court of Appeal by Mr. Jones in 2005, but HMRC then petitioned the House of Lords for a further appeal in 2006. However, in July 2007, the House of Lords rejected the appeal by HMRC.

 

Shortly after the House of Lords voted in favour of Arctic Systems, the government announced plans to bring forward ‘income splitting’ legislation to nullify the tax advantages that had been gained by the Jones’

 

'Income Splitting' legislation

December 2007 saw the government publish draft legislation that was focused specifically on income shifting arrangements that made use of companies to gain a tax advantage.

Under the legislation, taxpayers must detail how much income they have ‘foregone’ by making a comparison with how the business would have operated, had all their work been done independently on a fully commercial basis.