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The Ruling
Lord Hoffman delivered another outstanding judgement today in this well-known test case, supported by four other Law Lords.  He concluded that the arrangement whereby a share in Arctic Systems was subscribed for by Mrs Jones was indeed a settlement (an arrangement whereby Mr Jones gave something of value to Mrs Jones). There was the requisite element of bounty, since it was plainly intended that Mrs Jones received a benefit from the share, in the form of dividends which, due to the level of her other income, would effectively be tax-free.  However, the case fell within an exemption in the settlements legislation, intended to benefit transfers between spouses (now including civil partners), since what Mrs Jones acquired was property (the share in the company, with all the normal rights that attach to a share), rather than a right to income.  The fact that Mrs Jones subscribed for the share directly, rather than it being given to her by Mr Jones made no difference to the analysis.

Effectively, the law lords dismissed the Revenue’s argument that everything – the share subscription, the low level of salaries paid and the dividends – was a single settlement, amounting to a right to income and thus taxable under the settlements legislation on Mr Jones.  Instead spouses may transfer property between themselves from which future income in derived.  Lord Hope and Lord Neuberger said that ordinary shares in a company will always qualify for the exemption (although preference shares may not).

Deloitte’s response
Patricia Mock, Director in Deloitte Private Clients said: “The result will be welcomed by many small businesses, where joint ownership of shares and the payment of dividends have become increasingly popular. However, it must be acknowledged that this is a planning technique designed to save tax, as pointed out by Lord Hoffman.  The savings come in two ways – paying dividends instead of salary saves employers’ and employee national insurance – and paying some of those dividends to a basic rate taxpayer (Mrs Jones in this case) may save the higher rate supplement.  Assuming a small company earns income after expenses of £60,000, paying it all as salary to one person would mean tax would be paid at an effective rate of over 37%.  Paying the same amount as a dividend to one person would give an effective rate of just over 24%.  Paying it as dividends to two people reduces the effective rate to 20%. By contrast, an individual earning £60,000 as a self-employed person (rather than using a company) would have an effective tax rate of just over 30%.”

Bill Dodwell, Deloitte tax partner commented: “The result from this case is that the Treasury will need to consider the right tax policy here.  Gordon Brown, in his last Budget, increased the small companies rate of corporation tax over 3 years from 19% to 22%, specifically to increase the rate of tax borne in this situation.  Very small businesses, such as Arctic Systems, have provided a considerable boost to the economy over the last ten years and bear considerable risk, since their income has much less security than is the case for employees.  They also have to bear their own pension costs.  In the light of these factors, we believe there are very strong arguments in favour of leaving the current system unchanged.”

“However, if the Treasury were to adopt a different policy, we believe that it needs to be explained very carefully to small business and advance warning given of any new system, so that small businesses and their advisers can adapt to what for many could be a considerable tax increase."

Note to editors

About Deloitte
In this press release references to Deloitte are references to Deloitte & Touche LLP, which is among the country's leading professional services firms.  Deloitte & Touche is the United Kingdom member firm of Deloitte Touche Tohmatsu ("DTT"), a Swiss Verein whose member firms are separate and independent legal entities.  Neither DTT nor any of its member firms has any liability for each other's acts or omissions.  Services are provided by member firms or their subsidiaries and not by DTT.  Deloitte & Touche LLP is authorised and regulated by the Financial Services Authority. The information contained in this press release is correct at the time of going to press.