In their judgment, handed this morning, the lords ruled that:

• The Jones created an arrangement in the nature of a settlement when they planned, and subscribed for one share each, and set up their company Arctic Systems Ltd
  
  
• However, the exemption for gifts between spouses also applied and so dividends paid to Mrs Jones were therefore not income arising under a settlement.

The Jones were jubilant after the landmark decision, which was not totally unexpected by HMRC, (the Court of Appeal had previously and unanimously found in favour of the taxpayer), but Geoff Jones said that he is "extremely angry" about HMRC's failed "stunt".

HMRC will now have to review and totally re-write its guidance on settlements and also review its guidance on outright gifts. Small business taxation is somewhat topical as the Muirless Review on the subject expected this Autumn, and there is speculation as to what view the new chancellor will take on small companies and their dividend policy.

In a statement released today, HM Revenue and Customs say that they "are currently considering the details of the judgement and a further statement will be made later."

Concerns about the long term outcome of the case have already been voiced by Francesca Lagerberg, Chair of the ICAEW Tax Faculty Technical Committee, who urges the government "not to make any knee-jerk reactions as a result of this decision." She suggests instead that there is "a need for government to ensure tax policy supports business and provides them with clarity and certainty.”

Jones v Garnett a.k.a. "Arctic Systems": This article presents a brief overview of the decision, and looks at some of the additional points raised by the law lords in their judgments.

The five law lords, Lord Hoffman, Lord Hope of Craighead, Lord Walker of Gestingthorpe, Baroness Hale of Richmond and Lord Neuberger of Abbotsbury found unanimously in favour of the taxpayer Mr Geoff Jones, in their judgement released on the 25th July, however, they each gave us a few extra reasons for reaching the decision that they did.

The decision
The Lords decided that Geoff Jones was the settlor of a settlement, and that the term "settlement" catches an arrangement as simple as an incorporation of a new venture. Mr Jones allowed his wife to subscribe to half the share capital of a new company, and he then worked for the company, allowing her to share in the future profits of the company which could be generated by any computer consultancy contacts that he chose to enter into. Lord Hoffman described the decision to set up the company in this way as “tax motivated and not commercially driven”.

Mrs Jones ordinary shares were found to contain an element of hope value, in that she had an expectation that her husband would generate income for her to partake in the form of dividends. Mr Jones would not have given up income in similar circumstances to anyone else other than a family member. Mrs Jones shares, by this reckoning were potentially worth more than the £1 she paid for them and Mr Jones was potentially giving up future income although no contracts where in place when the shares were acquired. These elements meant that there was a bounteous transaction, and so this was enabled by way of a gift. As there was a gift, the exemption for outright gifts applied per s 660A (6)

Finally, addressing the question of whether or not income producing ordinary shares were wholly or mainly a right to income, the Lords all agreed that they were not. They confirmed that ordinary shares confer a bundle of rights which are over and above the right to income. Preference shares, it should be noted, following Young V Pearce [1996[ 70 TC 331 are accepted as wholly or substantially a right to income, as they have no voting rights, and limited rights on winding up.

Additional points made
“Wholly or substantially a right to income”
Lord Hope decided to explore this part of s 660A (6) as it is “an important point of general public interest”, he agreed with the points made above, but in reference to the capital value of a company, he suggested that rights to income should not be weighed up by reference to the capital value at the time of the gift. This is a logical approach it seems, as companies build up reserves over a period of time, and on day one, a share is only going to be of nominal value.

On the statutory definition of a settlement
Lord Walker decided to address “some other problems arising with the definition of “settlement” as including “arrangement” in his judgment. He found that an intention to avoid tax is not an essential agreement for a settlement, but there is no set of tests to identify what components should be present to create the sufficient unity that must be present to comprise a settlement. He did not agree with HMRC’s contention that the settlement in this case was as wide as they inferred, but was content to agree that in this case, the settlement was limited to the setting up the company in accordance with the accountant’s advice combined with a common intention by Mr and Mrs Jones to minimise tax.

But...was there really a settlement?
Baroness Hale took us through the history of taxation of wives in her judgment, and she went back to the basic conundrum of whether a husband and wife “team” created a settlement, and if so, how do you unpick genuinely co-operative family ventures? She suggests that really the only way to make this work is that one should assess the couple year on year for their respective input and then work out their reward and presumably tax them thereon. HMRC had decided to apply the settlement provisions to the case in blanket form, and so she did not agree with this interpretation... She felt it would be “presumptuous” of her to rule that there was no settlement on this occasion as the decision to reject HMRC’s appeal was unanimous in any case.

Share valuations
Lord Neuberger added that Mrs Jones share had “substantial value” when allotted, as long as she was the owner and Mr Jones owned the other share. This further firms up the unanimous view that the share purchase enabled a gift between spouses. Lord Neuberger also found bounty in the decision each year by Mr Jones to take a low salary, but he pointed out that this was a point not pressed by either appellant or respondent, and so he took it no further. On the gift exemption, he was of the opinion that Mrs Jones purchased her share effectively at an undervalue, and he also looked at the rights of the share purchased, concluding that its future rights had to be considered, thus agreeing with Lord Hope’s analysis of share rights.

Some additional points of interest
By upsetting the Court of Appeal’s judgment and finding that there was a settlement, the Lords have left many questions unanswered, but do not feel disappointed, as by confirming that the outright gift exemption is effective in these cases, many of these undecided questions do not matter now - for spouses anyway. We have in short, a victory for common sense, and family tax will be a lot easier to understand as a result; many of these unanswered questions were actually totally unanswerable, and even if you could answer them, how would you ever self assess year on year? Happily, this is another unaswerable question that we no longer need to consider.

• There was concern as to how much capital you should leave in a company to ensure ordinary shares were more that a right to income. Post verdict: It no longer matters, ordinary shares are confirmed as a bundle of rights.
  
  
• There was concern that the non fee earning spouse must work or contribute in some way to what is now accepted as the fee earners’ business. Post verdict: This is no longer a concern; providing the gift is effectively outright the spouse needs no input...
  
  
• There was concern that shareholders should pay a salary at a commercial rate, to remove their companies from “the radar” if nothing else. Post verdict: It no longer matters, if you have created a settlement, then the outright gift exemption applies.

Source: Nicola Ross Martin, Accounting Web.