HMRC lose another ‘settlements’ case.
HMRC have recently lost another tribunal case involving small company dividends received by one spouse under an alleged settlement arrangement. The arguments involved being similar to those in the famous Arctic Systems (Jones v Garnett) case.
The facts in Patmore vs HMRC however were unusual due, in part to the share structure and the financial arrangements related to the initial acquisiation of the shares. However, the fact that HMRC took the case shows that losing Arctic Systems has not stopped them from challenging cases where they believe that dividends received by one spouse should be taxed on the higher earning spouse.
The case revolved again around the ‘settlements’ legislation under what was s660a ICTA 1988. The disputed tax assessments in this case covered the four years 1999/00-2002/03. The tax at stake was less than £20,000 although the decision may have affected the tax position in more recent years as well.
In the late 1990s Mr and Mrs P agreed to pay £320,000 to buy the small manufacturing company for which Mr P worked. The first instalment of £100,000 was funded by a second mortgage the couple took out on their house. Mr P took 83 shares giving him, together with his existing 15 shares, a 98% shareholding. Mrs P received 2 shares giving her a 2% shareholding. Mr P became the sole director and Mrs P became company secretary. Two months later the existing 100 shares were re-named A shares. 100 new non-voting £1 shares were created and called B shares. 10 were allotted to Mrs P. At this stage Mr P owned 97% of the nominal value of the shares.
Dividends were paid on the B shares between 1999 and 2003. 40% of these being due to Mrs P although all dividends were immediately credited to Mr P’s loan account to set against the outstanding purchase payments for the company. HMRC argued that under this arrangement, all of the dividends should be taxed on Mr P as a settlor.
In HMRC’s view Mr P owned the company and used his control of it to declare significant dividends. His wife’s dividends were subject to less tax than if Mr P had received them directly. However Mrs P never received the dividends as they were always retained by Mr P to repay the outstanding debt.
The judge noted that the settlements legislation does not contain a motive test so it was irrelevant that tax efficiency was part the underlying philosophy for the company structure. She also determined that the approach used to acquire the shares did not create a settlement under s660, but “a constructive trust in Mrs P’s favour”.