HL 2007, 78 TC 597;  STC 1536;  UKHL 35;  4 All ER 857
This is one of the most important tax cases in recent years and the outcome was highly relevant to a great many taxpayers and the outcome was of great significance.
An IT consultant, Mr Jones, purchased a newly-incorporated off-the-shelf company and retained one of the two issued shares, and gave the other to his wife. The taxpayer 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 the taxpayer carrying out the consultancy work, while his wife carried out some administrative work, totalling about four or five hours per week. The company paid them both small salaries but large dividends.
HMRC argued that the payments made to the taxpayer’s wife 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 firstly 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, s 626.
The House of Lords rejected Mr Jones’ contention that there was no settlement, stating that the transaction would not have occurred at arms length with an unrelated third party and 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 s 626, so that the charging provision in s624 did not apply.
Lord Hope of Craighead observed 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 taxpayer’s appeal was therefore upheld.