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Arctic Systems

This is one of the most important tax cases in recent years - the outcome was highly relevant to many freelance contractors who own and operate limited companies.

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An IT consultant, Mr Jones, purchased a newly incorporated company (Artic Systems Limited) and retained one of the two issued shares, while the other share was given to his wife. Mr Jones was appointed as the company's sole director, while his wife was appointed company secretary.

The company began to carry on an information technology consultancy business with Mr Jones carrying out the consultancy work. Mrs Jones carried out some administrative work that totalled approximately five hours per week. The company paid them both small salaries but large dividends.

HMRC argued that the payments made to Mrs Jones were disproportionate to her contribution to the business and raised assessments on Mr Jones, treating the income as his, on the grounds that this represented a settlement under ICTA 1988, s660A and was taxable under ITTOIA 2003, s624.

Mr Jones appealed, contending that the distribution of the company's profits did not amount to a 'settlement', and that the transfer of the share to his wife had been an outright gift to his wife, within the exception in ITTOIA 2005, s626.

The House of Lords rejected Mr Jones’ contention that there was no settlement, stating that the transaction contained a sufficient element of bounty to constitute a settlement. However the transfer of the share to Mrs Jones had been an outright gift between spouses, within s626, so that the charging provision in s624 did not apply.

Lord Hope of Craighead stated that 'an arrangement by which one spouse uses a private company as a tax efficient vehicle for distributing to the other income which its business generates is likely to constitute a “settlement” on the other spouse, but so long as the shares from which that income arises are ordinary shares, and not shares carrying contractual rights which are restricted wholly or substantially to a right to income, the settlement will fall within the exception”. The appeal made by Mr Jones was therefore upheld.

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Disclaimer: The above information does not constitute professional advice, only general information.