Husband and Wife companies - The Arctic Systems Case Update - 24.03.06

Over the last few years our clients with husband and wife companies and those considering operating their business in this way will have been closely following the progress of the Jones v Garnett legal case, also known as The Arctic Systems Case.

Using this as a test case, HM Revenue and Customs have sought to challenge the tax planning of setting up companies in which both husband and wife are shareholders and where the income has been divided between the couple to maximise the use of basic rate tax bands. The legislation HMRC were seeking to apply to this situation has become known as “the settlements legislation”. A successful challenge by HMRC would have led to the dividends that had been paid to Mrs Jones being reallocated and taxed on Mr Jones, resulting in further tax being due and interest being charged on the underpaid tax.

Current legal position
On 15th December 2005, the Court of Appeal held that “the settlements legislation” did not apply to Mr & Mrs Jones, shareholders of Arctic Systems Ltd. This meant that the dividends Mrs Jones received from Arctic Systems Ltd, the couple’s jointly-owned company, were taxed on Mrs Jones and not reallocated to her higher taxpaying husband.

On 13th January 2006, HMRC issued a statement confirming that they have decided to petition the House of Lords for leave to appeal against the Court of Appeal decision, having been refused leave to appeal by the Court of Appeal itself.

On 24th March 2006, HMRC were granted leave to appeal to the House of Lords against this decision. Opinion amongst the professional bodies is that it will be several months before this appeal is heard and that the judgement will be handed down towards the end of the year.

Until then the final position with regards to the application of “the settlements legislation” will remain uncertain.

Current advice on how to act – where your case is similar to the Joneses’ in key areas
Where the circumstances surrounding a husband and wife company are sufficiently similar to those in Arctic Systems Ltd the advice, issued in a joint guidance note by the UK’s six main tax advisory professional bodies, is that there is no need for any self-assessment or disclosure of dividends paid by a jointly-owned company to the lower tax paying spouse. The dividends should be included in the self-assessment returns of the receiving parties as for any other dividends.

If as a result of this advice you wish to amend your tax return for the year ended 5 April 2005, you have until 31 January 2007 to do so. If necessary, it may be possible to amend tax returns for earlier years under the “error or mistake” provisions, although it is currently unclear whether HMRC would accept such a claim. Please contact your account manager if you wish to discuss whether any amendments are appropriate to your returns.

However, be aware that the position could change again should the House of Lords grant HMRC leave to appeal. Watch this space for more news.

Current advice on how to act – where there is uncertainty as to whether your case is sufficiently similar to the Joneses’
If your case is similar to one of the examples listed in the Inland Revenue (now HMRC) Tax Bulletin of April 2003, in which they set out their view as to how the settlements legislation works, we will need to consider whether the facts of your situation are sufficiently similar to the Joneses’ that the Court of Appeal decision will apply.

If this is not the case then there are 2 alternative routes:

• White space disclosure
  In order to avoid a later discovery assessment, should HMRC decide that the settlements legislation does apply in your case, your tax return should disclose as additional information (in the white space) that the Revenue guidance indicates that the settlements legislation (s660A) may apply but no adjustment has been made in the return in this respect.
  
  Please discuss with your account manager whether such disclosure is necessary in your case and appropriate wording for that disclosure.
  
  You should be aware that should the House of Lords find in favour of HMRC then interest will arise on the unpaid tax and there is also a possibility of penalties should HMRC conclude that your position with respect to the settlements legislation was “unreasonable”. You should also be aware that a note in the white space of the tax return for one year could result in an enquiry into earlier years.

• No white space disclosure
  
  In the view of the professional bodies there is no requirement under tax law for a taxpayer to disclose where he has interpreted a doubtful issue in his favour, assuming of course that the return is correct and complete and non-application of the settlements legislation is a “reasonable” position to take.
  
  Therefore you as the taxpayer may decide not to make a white space disclosure and to deal with any enquiry or discovery assessment if this should occur.

For background information on the Arctic Systems Case, click here

What action should I take?
If you feel you are affected by the Settlement Legislation or wish to know about the implications of the Arctic Systems Case, please get in touch with one of our consultants at Andrew Webster Limited by calling 01223 507080 or e-mailing info@tax.uk.com

Important: This note on the Settlement Legislation is for the purpose of guidance only and further professional advice should be obtained from your Account Manager before acting on any information contained herein. Andrew Webster Limited will not accept any responsibility for loss caused to any person(s) whatsoever as a result of action taken or refrained from based on the content of this note.