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

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    68.  I would have found it easier to understand the Revenue's case if it had adopted a year by year approach: looking at each tax year, has one of the spouses worked for a salary which is seriously less than his services are worth to the company in order to boost the company's profits which can then be distributed equally between the spouses as dividend? In other words, has there been a gratuitous transfer of income between husband and wife? This would be a practical way of catering for the uncertainties and vicissitudes of family life and family business, while meeting the policy objectives discussed earlier.

    69.  But the Revenue has expressly eschewed that approach. It relies on the initial acquisition of the company's shares as the "settlement". It has also expressly eschewed the intention of catching any other type of arrangement than that in example (iv) above. It is not interested in picking apart genuinely co-operative family ventures, even if on analysis the contribution of one spouse is worth more than the contribution of another. Nor can it be interested in arrangements which start out as roughly equal ventures but for one reason or another become less equal as time goes by. On the Revenue's case, it is only a "settlement" if a substantial element of "bounty" - that is, gratuitous transfer - is contemplated at the outset. It must follow that unanticipated later events cannot transform the character of the initial transfer of property or arrangement.

    70.  The problem with that approach, as my lords have shown, is that what makes the arrangement gratuitous (I refuse to use the patronising and inaccurate term "bounteous") also makes it a gift. And an ordinary share carries with it much more than a right to income. So the exception in section 660A(6) applies. As already seen, there is nothing contrary to policy in one spouse making an unconditional and irrevocable transfer to the other of property even if it carries with it the right to substantial unearned income.

    71.  Thus my reservations about the Revenue's case that this is a settlement at all are very similar to those of the Chancellor: it only becomes a "settlement" within the meaning of section 660A(1) because of expectations about later events which are too uncertain and fluid to be included as part of the initial arrangement. However, in view of our unanimous conclusion that this appeal should be dismissed, it would be presumptuous of me to reach a different conclusion on the settlement point.

LORD NEUBERGER OF ABBOTSBURY

    My Lords,

    72.  I have had the benefit of reading a draft copy of the speeches of my noble and learned friends Lord Hoffmann and Lord Walker of Gestingthorpe, and I am of the view that this appeal should be dismissed for the reasons they have given. The case raises points of some difficulty, it is significant to a number of people, and it has attracted media coverage in the professional press, and, unusually for a revenue case, more widely. Accordingly, I propose to express my views in my own words.

    73.  This appeal raises two issues in relation to section 660A of the Income and Corporations Taxes Act 1988. The first issue is whether, there was, on the facts of this case, "a settlement" within the meaning of section 660A(1) as expanded by section 660G(1). If the answer is in the affirmative, then the second issue which arises is whether, on the facts of this case, there was "an outright gift" within the meaning of section 660A(6). In order to succeed on their appeal, and establish that the dividends received by Mrs Jones are to be treated as the chargeable income of Mr Jones, the Revenue need to make good their contention on both issues, namely that there was "a settlement", and that it did not amount to "an outright gift".

    74.  The difficulty arising from the two issues is well illustrated by the difference of judicial opinion in this case. The senior general commissioner found for the Revenue on both issues; the junior commissioner found against the Revenue on both issues. Park J found for the Revenue on both issues but his main reason on the second one was different from that of the senior commissioner. The Court of Appeal found against the Revenue on the first issue, but would have been for the Revenue on the second issue, although disagreeing with the reason of the senior commissioner. Your Lordships agree with the Revenue on the first issue, but are against them on the second.

    The first issue: was there an "arrangement"?

    75.  The definition of "settlement" in section 660G (1) appears, on its face, to be very wide indeed, and its ambit (or, to be more accurate, the ambit of its statutory predecessors) has been somewhat circumscribed by the courts. It is not surprising that the legislature and the courts have been content for the law to develop in this way. One of the principal purposes of section 660A is (save in certain circumstances - see e.g. section 660A(6)) to defeat arrangements between spouses, not conducted at arm's length, which seek to equalise their income, thereby reducing their aggregate liability to income tax and national insurance charges. The legislature has given effect to this by defining "settlement" in very wide terms, and the courts have then given the definition a limited effect, by means of the technique of purposive interpretation, through the introduction of the concept of "bounty" - see for instance per Lord Wilberforce in Inland Revenue Commissioners v Plummer [1980] AC 896 912E-F.

    76.  The word "bounty" rings slightly uncomfortably, at least to my ears. It seems a somewhat outdated expression which smacks of condescension. However, in the light of the judicial decisions on these provisions, it seems to me that the law is now tolerably clear and sensible, and, particularly given the need for clarity and the room for difficulties in this area, it would be inappropriate to risk introducing uncertainty or new complications by redefining the principles, even if only linguistically.

    77.  The dispute between the parties on the first issue is whether there was an "arrangement" falling within the ambit of sections 660A (1) and 660G (1) when one of the two subscriber shares in Arctic Systems Ltd ("the company") was transferred to Mrs Jones on 11 August 1992, in the circumstances explained by Lord Hoffmann. For the taxpayer, Mr Gammie QC contended that this did not amount to an "arrangement" because it lacked the necessary element of bounty. He relied on the fact that the company had no assets other than the £2 derived from the two subscriber shares: therefore Mrs Jones got what she paid for. The profits which subsequently accrued to the company through the skill and efforts of Mr Jones were no more than a hope or at best, an expectation, that could not, he said, be counted as an asset of the company because the company had no legal right to require Mr Jones to work, whether for the company's benefit or at all, let alone for a reduced level of remuneration.

    78.  In my judgment, although the Court of Appeal was convinced by that argument, it is inconsistent with both authority and principle, and should be rejected.

    79.  It seems to me clear that, when considering whether there was an "arrangement" within the meaning of the sections, i.e. an arrangement which involved an element of bounty, one should assess the position at the time that the alleged arrangement was made, but, in carrying out that exercise, one should not disregard what happened thereafter. In particular, if the parties intended an element of bounty to accrue, and that element of bounty does indeed eventuate, then, absent any other good reason to the contrary, there is indeed an "arrangement" within the meaning of section 660G (1).

    80.  In this connection, as long ago as 1940, in Commissioners of Inland Revenue v Payne (1940) 23 TC 610, Sir Wilfred Greene MR discussing a somewhat more simply drafted statutory predecessor of the sections in question here, namely section 38 of the Finance Act 1938, said this, at p 626, in relation to a scheme whose details are not of significance for present purposes:

    "The word 'arrangement' is not a word of art. It is used, in my opinion, in this context in what may be described as a business sense, and the question is: can we find here an 'arrangement' as so construed? It is said that the only element in this transaction which falls within the definition of 'settlement' is the deed of covenant itself. I am unable to accept that argument. It appears to me that the whole of what was done must be looked at; and when that is done, the true view, in my judgement, is that Mr Walter Payne deliberately placed himself into a certain relationship to the company as part of one definite scheme......He did it by a combination of obtaining the control of the company, entering into the covenant and then dealing with the company in such a way as to achieve his object" (emphasis added).

    81.  Crossland (Inspector of Taxes) v Hawkins [1961] 1 Ch. 537 is another decision of the Court of Appeal which appears to me to be in point. It was a case concerned with sections 397 and 403 of the Income Tax Act 1952. Again, the detailed facts do not matter. What seems to me to be important for present purposes is what was said by Donovan LJ at 547:

    "I will accept for the moment the proposition that the family settlement which followed was not decided upon at the outset; but what is important I think, is that the eventual enjoyment by some individual or individuals of the money which had escaped surtax must have been in contemplation at the outset. Otherwise, as I say, the scheme had no rational purpose".

    82.  I am prepared to accept that in the present case the formation of the company and (more arguably) the allotment of shares had a "perfectly rational purpose", even without the benefit of seeking to equalise the income of Mr and Mrs Jones. However, it seems to me that Donovan LJ's essential point was that, when considering the alleged "arrangement", or to put the same point in another way, in considering whether the arrangement involved an element of bounty, one looks at the whole of the purpose of the arrangement, and, in that connection, one does not shut ones eye to whether that purpose was achieved. That point is reinforced by what Donovan LJ went on to say at 550:

    "Bearing in mind the ultimate object of securing money free from the burden - or the full burden - of surtax, can it matter for present purposes that the precise way of securing this result was not decided upon at the very outset? I think not".

    83.  On the following page, Donovan LJ specifically disagreed with the view of the judge at first instance that "the deed of settlement came later in date [and the commissioners had found] that there was no comprehensive arrangement at the outset of which the deed of settlement formed part". It is true that, at that point, Donovan LJ was dealing with a question of the identity of the settlor. However, the definitions of settlement in section 660G(1) and of a settlor in section 660G(2) are closely connected, and it appears to me to be perfectly proper to rely upon observations as to what can be taken into account when considering who is a settlor, when deciding whether there is a settlement.

    84.  Finally, there is the first instance decision in Butler v Wildin (1988) 61 TC 666. Again, it is unnecessary to go into the facts. The important feature for present purposes is that Vinelott J concluded that there was a settlement within the meaning of the immediate statutory predecessor of section 660G(1), namely section 681(4) of the 1988 Act, notwithstanding that, at the time the shares in the company in that case were allotted, it had no right to the benefit of the contract which was ultimately vested in it. The essential point is that the company in question was set up by the taxpayer, and the shares were allotted, in the expectation, indeed with the intention, which duly eventuated, that the benefit of a potentially valuable contract being negotiated by the taxpayer would be taken in the name of, and for the benefit of, that company.

    85.  Mr Gammie suggested that these cases were distinguishable on the ground that the beneficiaries were the children or grandchildren of the taxpayer, and not as in this case, a spouse. However, although it is fair to say that the statutory provisions relating to the transfer of income-producing assets to a spouse are somewhat different from those relating to children, it seems to me that the applicable principles as to whether a "settlement" has been created must be identical. This is demonstrated by the fact that the provisions of section 660G apply equally to the provisions of section 660B of the 1988 Act ("Payments to unmarried minor children of settlor") as they do to section 660A, which, save in respect of subsection (6) which applies only as between spouses, is general in its application ("Income arising under settlement where settlor retains an interest").

    86.  In this case, as the facts recited by Lord Hoffmann show, the main reason for allotting one share in the company to Mr Jones and the other share to his wife, and the only reason that Mr Jones was intending to accept, and duly accepted, an artificially low rate of remuneration for his work, was to distribute the income earned by Mr Jones roughly equally between him and his wife. That was the intention of Mr and Mrs Jones (or, perhaps more accurately, the intention of their accountants, which they were happy to adopt) at the time the company was set up, and it was what happened in each financial year (with the exception of two years when, for reasons not germane for the present purposes, owing to a misunderstanding of the law, Mr Jones was paid effectively a full salary). Accordingly, unless we are to overrule the approach adopted by the Court of Appeal in Payne and Crossland, and by Vinelott J in Butler v Wildin, it seems to me to follow that that there was here an arrangement within the meaning of section 660G(1). In my view, those cases laid down an approach which is workable and fair, which appears to give effect to the legislature's intention, and which, despite opportunities to do so, the legislature has been happy to accept by implication, in that nothing in the various re-enactments since section 38 of the 1938 Act has called the approach into question.

    87.  It also appears to me that the conclusion is consistent with principle. The fact that the company had no legally enforceable right to require Mr Jones to work for it, either at all or at a reduced level of pay, does not mean that that was not something that the company and its shareholders expected to happen, and which therefore gave the shares value. As Lord Hoffmann pointed out in argument, valuation of an asset, whether land, shares, intellectual property or anything else, is very often based, at least to some extent, on profits which may be hoped or expected to be realised, but to which the owner of the asset has no present legal right. In this case, it can be said that there is a curiosity in that the hope and expectation of profits accruing to the company were (and no doubt still are) limited to the extent that the two shares were owned by Mr and Mrs Jones. In other words, that Mrs Jones's share only had a substantial value at the date it was allotted to her as long as she was its owner and Mr Jones owned the other share. However, the notion that a particular piece of property has value (or has considerably enhanced value) only so long as it is owned by one particular person or class of person, because of some attribute which that person enjoys, or only so long as a particular state of affairs subsists, is conceptually unsurprising and not unfamiliar in practice.

    88.  The essential point here is that, in the light of reasonable expectations as to what Mr Jones would achieve in terms of winning contracts for the company and would be prepared to accept by way of remuneration (which expectations were in due course fully realised), the value in 1992 to Mrs Jones of her share was considerably greater than the £1 which she paid. In those circumstances, there was indeed an element of bounty involved in her acquisition of the share, and that bounty was provided through the expectation of what Mr Jones would do. The fact that the bounty primarily arose from an expectation of what he would do, rather than from what he had done, does not appear to me to be in point.

    89.  There is an additional problem if the argument of the taxpayer is correct. If the Revenue's case on the first point is successfully met by the contention that one should limit one's attention to the strictly legally enforceable rights of Mr and Mrs Jones and the company at the time that Mrs Jones acquired her share, then that would open the door to a different approach. That approach would involve considering what transpired each year, when it was decided how much of the company's gross profit should be attributable to Mr and Mrs Jones' respective wages, and how much should be distributed by way of dividend. Such an approach was raised in argument by my noble and learned friend Baroness Hale of Richmond, but it was not adopted by either party. However, if Mr Gammie was correct in his argument on the first point, then, when Mr Jones, as the sole director of the company, decides each year how to apportion the gross income of the company, I find it very hard to see why that should not be capable of being an arrangement within section 660G (1), if it has been excluded from consideration as part of the arrangement when the shares were acquired by Mr and Mrs Jones. On that basis, I find it also very hard to see why Mr Jones's decision each year not to take anything like a full salary, thereby increasing substantially the dividend payable to his wife, does not involve an element of bounty. Neither Mr Furness QC (no doubt reflecting the Revenue's policy) nor Mr Gammie (as it would involve his clients losing on this issue) was prepared to adopt this approach. Although it appears to me to be logically attractive, it would be inconvenient in practice, in that it would be difficult to administer, and it might well produce unfair, even arbitrary, results. However, the fact that it is not adopted by either party, seems to me rather to support the Revenue on the first issue.

    The second issue: was there an "outright gift"?

    90.  That then brings me to the question of whether, although the transfer of the share in the company to Mrs Jones constituted a "settlement" within section 660A (1), it is nonetheless taken out of the ambit of that section by virtue of being an "outright gift" within section 660A (6). In that connection, three different arguments were raised by the Revenue as to why there was no such "outright gift" in the present case.

    91.  The Revenue's first argument was that Mrs Jones paid £1 for her share, and that therefore there was no "outright gift", merely a purchase at an undervalue. In my opinion, that point will not do, and it was not strongly pressed by Mr Furness. A purchase at an undervalue involves, as a matter of ordinary language, an element of gift. There was a "settlement" in the present case because there was an "arrangement", and there was an "arrangement" because, for the reasons already explained, there was a substantial element of "bounty" when Mrs Jones acquired her share. It seems to me very difficult to contend that there was a substantial element of bounty without there having been a gift, albeit that the value of the gift must be diminished by £1 to take into account what Mrs Jones paid for her share. To describe the element of gift in the arrangement as substantial is, in my judgment, a positive understatement in the light of the virtually nominal payment of £1. Once one accepts that there is a gift, it seems to me that the word "outright" is of no assistance in connection with this point.

    92.  The second argument advanced by the Revenue was that section 660A (6)(b) applied, on the basis that the share concerned was "wholly or substantially a right to income". This argument found favour with the senior commissioner, and, albeit after some hesitation, with Park J (see [2005] EWHC Ch 849, [2005] STC 1667 at para 46). However, I would reject it essentially for the reasons given by Sir Andrew Morritt C, in paragraph 97 of his judgment in the Court of Appeal, [2005] EWCA Civ 1553 [2006] 1 WLR 1123:

    "Each share carries a right to share in dividends duly declared. In addition each share carries the right to share in the distribution of assets in the event of members' winding up and the right to vote at general meetings of the company. The rights attaching to the ordinary shares in the company are unaffected by the alleged arrangement".

    It seems to me that an ordinary share, whether in a private or a public company, is for these reasons to be distinguished from a preference share which was held to fall within the ambit of the statutory predecessor of section 660A (6)(b) by Sir John Vinelott in Young v Pearce. It may be the case that the main, possibly the sole, reason Mrs Jones acquired a share in the company was to enable her to receive a substantial dividend each year, but section 660A(6)(b) is concerned with the objective character of the property involved, not the subjective reason for which it was acquired. In this connection, I have had the benefit of reading in draft the speech of my noble and learned friend, Lord Hope of Craighead, with which I fully agree.

    93.  The third, and to my mind the most formidable, ground relied on by the Revenue as to why there was no "outright gift" in the present case was that adopted by Park J as his primary reason (see paragraph 44 and 45), with which the Court of Appeal agreed (see paragraphs 91-93). This argument is that there was "no outright gift" at all. In this connection Mr Furness pointed out that section 660A (6) can only be relied on by a taxpayer where the "settlement" constitutes an "outright gift" and that the reason that the Revenue succeeded on the first main issue is that the "settlement" was more than an outright gift of the share acquired by Mrs Jones (less £1). As Park J put it in paragraph 44 of his judgment:

    "The 'settlement' was an arrangement which included the following elements: the acquisition by Mrs Jones of one share in the [company] for £1; Mr Jones serving the company as an employee; an expectation that he would draw only a modest salary; and an intention that profits would be paid out as dividends. There was far more comprised in that arrangement than would be covered by the expression 'an outright gift'".

    94.  I see the force of that point, particularly as section 660A (6) is concerned with the question of whether the "settlement", as opposed to the transfer of the property comprised in the settlement, constituted an "outright gift". However, it seems to me that the point wrongly detaches the bounty from the property, and that it contains an element of inconsistency, which is rather similar to the inconsistency in the proposition that, because the share was acquired for £1, it cannot be treated as a gift. The only reason that there is a settlement in the present case is that there is an arrangement involving the acquisition of a share which includes an element of "bounty", as a result of what it is anticipated will happen following the acquisition of the share. In other words, the only reason that there is an "arrangement" is that the share acquired by Mrs Jones was, at the time of acquisition, worth more than she paid for it. I therefore find it difficult to see how one can detach the bounty from the property. The notion that there is a gift of the share arises because of what was anticipated, indeed what was intended, to happen in the future.

    95.  One could not, I think, say that the gift of a share in a publicly quoted company could not operate as "an outright gift" because the value of the share is not, as it were, inherent, but is based on what it is hoped will happen in the future. The only ground for suggesting that such an approach is justified in the present case is that the existence and value of the bounty would depend on what one or both of the parties involved in the arrangement, as opposed to third parties, will do in the future. However, I do not see that as a logical or satisfactory reason for concluding that the "settlement" in the present case did not involve "outright gift".

    96.  I cannot pretend to have found this third point easy, and it is not surprising that Park J and the Court of Appeal reached a different view. However, in common with your Lordships, I have concluded that the Revenue's appeal fails on this ground.

    Conclusion

    

 
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