The House of Lords has unanimously found for the taxpayers in Jones v Garnett [2007] UKHL 35, upholding the decision of the Court of Appeal, although for different reasons.
The facts are well known by now. Very briefly, when he was made redundant, Mr Jones decided to become a freelance computer consultant. He and his wife acquired Arctic Systems Ltd off the shelf, each being issued one ordinary share. He was the sole director, she was the company secretary. He generated the income of the company by working full time for clients, she worked for about four to five hours a week on administration. They both took low salaries and paid out the majority of the income of the company to themselves equally as a dividend.
There were two points at issue. First, did this constitute a settlement (under the wide definition for income tax which includes 'arrangements') under which income was payable to the settlor's spouse (TA 1988, s 660A(2))? Second, if it was a settlement, was it excluded from charge by subsection 6, on the grounds that it was an outright gift from one spouse to another, which was not wholly or substantially a right to income?
The Court of Appeal had found that the issuing of the share was not a settlement because Mrs Jones had paid the par value of £1 for it, and that any future plans and income were too uncertain to be part of the arrangements. However, if it was a settlement, Sir Andrew Morritt at least would have found that it was not an outright gift.
Was there a settlement?
Although all the judges gave separate judgments at least on some part of the case all the other judges said they agreed with Lord Hoffmann and Lord Neuberger, whose judgments are therefore analysed in detail below.
In Lord Hoffmann's view it was necessary to take 'a broad and realistic view of the matter', relying particularly on the cases of Crossland v Hawkins 39 TC 493 and Butler v Wildin [1989] STC 22 which were also examples of a company being used as the vehicle for a settlement. In the former there was a contract with the company for Mr Hawkins to work for a low salary, in the latter the arrangement to transfer the land came later, but was always intended to take place if the development went ahead. In both of these cases Lord Hoffmann considered the subsequent plans could be taken into account in deciding if there was bounty.
Lord Neuberger argued along similar lines, saying (in a phrase that is likely to be quoted in subsequent cases) that:
'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)'
Lord Neuberger raises the alternative approach that the question of whether there was a settlement should have been decided each year, on the basis of the comparison of work put in to profits received for that year. He seems to see this as an argument that could only arise if the original issue of the shares was not seen as a settlement, and therefore appears to reject it because he decides that it can. However, it appears that Baroness Hale would have found it 'easier to understand the Revenue's case if it had adopted a year by year approach', and it looks as if she might well have found in their favour if they had. In fact, however, the Revenue specifically did not argue on those lines, no doubt (as Lord Neuberger recognises) because it would have been an administrative nightmare.
Outright gift
On the question of whether it was an outright gift, there were two arguments from the Revenue. The first was that there was no gift, Mrs Jones subscribed for her share. The second was that, if there was a gift, it was only part of the overall arrangement.
On the first issue, both Lord Hoffmann and Lord Neuberger dismiss the Revenue's arguments quite quickly: for the same reasons as there was bounty to create the settlement, there is a gift on any normal interpretation of the word. Lord Neuberger, interestingly, says that once there is a gift, the word 'outright' is of no assistance here.
On the second, which Lord Neuberger finds 'the most formidable ground', both judges eventually conclude that this is also part of the flipside of the bounty point in deciding whether there is a settlement, although each has a slightly different emphasis. The only reason there is a settlement is because of what is anticipated will happen with salaries and dividends. However, Lord Neuberger seems to see this as an integral part of the settlement and therefore part of the gift, whereas Lord Hoffmann says that the share transfer is the 'essence' of the arrangement, and the expectation of future events provides the bounty, but is not part of the arrangement itself.
Right to income
Finally, Mr Jones had to show that what he had transferred was not 'wholly or substantially a right to income'. Both Lord Hoffmann and Lord Neuberger disposed of this quickly; these were ordinary shares with rights such as sharing in assets at a winding up, blocking a special resolution, etc, over and above the right to a dividend if one is declared. The subsection is concerned with 'the objective character of the property involved, and not the subjective reason for which it was acquired,' as Lord Hoffmann put it.
The point was made even more strongly by Lord Hope, who concentrated on this point in his judgment. He distinguished in some detail the case of Young v Pearce [1996] STC 743 where the preference shares had deliberately been stripped of virtually all rights except their preference dividend if the ordinary shareholders voted one. He concludes 'So property given which consists of ordinary shares in a company will always attract the exemption in section 660A(6)'.
