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Mark McLaughlin CTA (Fellow) ATT TEP highlights two recent cases on the application of the 'settlements' income tax anti-avoidance rules in the context of dividend payments. 

Introduction

The Government may have shelved its proposed ‘income shifting’ legislation for now, but it seems that the ‘settlements’ anti-avoidance provisions are still alive and kicking even after the House of Lords decision in Arctic Systems, with two cases recently being heard before the Special Commissioners.   

Dividend waivers

In Buck v Revenue and Customs Commissioners [2008] SpC 716, Mr Buck owned 9,999 shares in the company out of 10,000. His wife owned the other share. Mr Buck waived dividend entitlements in respect of his 9,999 shares, which enabled enhanced dividends to be paid on his wife’s share. HMRC argued that the dividend waivers constituted a ‘settlement’, and assessed Mr Buck on the enhanced dividends. The taxpayer appealed, but was not represented at the hearing. The Special Commissioner dismissed the taxpayer’s appeal.

Looking at the facts, it is perhaps unsurprising that HMRC took this case and won. The company’s profits and reserves were modest for the two years in question. Mrs Buck received gross dividends of £39,371 and £27,774 in those years. If the company were to pay dividends at the same rate in respect of all its shares, it would have needed reserves of around £300 million!

When paying dividends following a waiver in similar circumstances, it is therefore important to ensure that there are sufficient distributable reserves to cover a dividend in respect of shares subject to the waiver.

There is a potential exception from the settlements provisions in respect of outright gifts between spouses or civil partners (ITTOIA 2005, s 626). However, this exception does not apply to gifts which only carry a right to income. The Special Commissioner held that there was no outright gift in this case, but a waiver of dividends. Mr Buck had retained the shares, rather than gifting them. Thus in contrast to the Arctic Systems case, the ‘outright gifts’ exception did not apply.   

Dividends to minor children

In Mr & Mrs Bird v Revenue and Customs Commissioners [2008], Mr and Mrs Bird were the initial shareholders of their kitchen furniture company, owning one share each. The company issued a further 98 shares at par, 19 shares each to Mr and Mrs Bird, and 20 shares to each of their three daughters. Dividends were paid to all the shareholders. HMRC argued that the dividends paid to the daughters (until they reached age 18) constituted income arising under a ‘settlement’, which should be treated as Mr and Mrs Bird’s income. The taxpayers appealed.

The Special Commissioner considered previous case law regarding the settlements anti-avoidance provisions, in which a corporate structure was used to provide income to a minor child. One of the cases (Butler v Wildin) was considered to be comparable to the situation in which Mr and Mrs Bird had made an ‘arrangement’ in the Commissioner’s view for their minor daughters to acquire a 60% equity stake in the company. 

On the question of whether there had been an element of ‘bounty’ in the arrangement (such that the arrangement could constitute a ‘settlement’), Mr and Mrs Bird (who were unrepresented) had contended that the daughters’ share acquisition was part of a commercial arrangement, as a ‘quid pro quo’ for loans made to the company out of funds inherited by the daughters. However, the Special Commissioner held that this argument was not sustainable in the particular circumstances. The taxpayers’ appeal was dismissed in respect of the settlements provisions.    

Fraudulent or negligent?

However, a further interesting point in this case was whether HMRC were entitled to make Extended Time Limit (ETL) assessments for tax years in which income had arisen outside the normal time limits. This was only possible if Mr and Mrs Bird had acted negligently in failing to include the minor daughters’ dividends on their own tax returns. The Special Commissioner asked what a ‘reasonable taxpayer’ would have entered on his or her tax return, and reviewed the information HMRC made available to assist taxpayers in completing their returns in respect of trust and settlement income. The Commissioner concluded that there had been no ‘negligent conduct’ on Mr and Mrs Bird’s part, and therefore the ETL assessments could not be made.   

Clearly, the ‘settlements’ provisions still need to be considered carefully in the context of family businesses, even after the Arctic Systems decision.

The above article is reproduced from 'Practice Update' (January/February 2009), a tax Newsletter produced by Mark McLaughlin Associates Ltd. To download current and past copies, visit: Mark McLaughlin Associates Practice Update Newsletters)