Memories of the S660a legislation

24th September 2013
Written by Qdos Contractor

Do you still need to be concerned about the settlements legislation?


It is over ten years now since some bright spark at HMRC decided it would be a good idea to wheel out trusts legislation dating back to the 1930's and use it against husband and wife companies to combat tax avoidance. This was legislation that was originally designed to prevent a settlor gaining a tax advantage in situations where one spouse could benefit from a trust. Thankfully it only took a relatively short period of time to put a stop to the Revenue's antics following the decision in the Arctic Systems case.




Prior to 2003 it had been standard practice for accountants and tax professionals to advise their clients to introduce their spouses as shareholders or partners in their businesses so as to maximise both couples personal allowances and basic rate tax bands thereby saving tax. Simple but efficient tax planning that still holds good today in certain scenarios.



Panic set in though following the publication of Tax Bulletin 64 when HMRC clarified situations in which S.660A ICTA 1988 would be applied, following a request by the Chartered Institute of Taxation. All of a sudden the tried and tested advice that had stood the test of time could be the cause of potential negligence claims should the clients of accountants have fallen foul of the legislation.


What is a settlement?


The legislation which is now contained within the provisions of S.624 ITTOA 2005 has a much wider meaning than the word 'trust' and includes situations where a transfer of income or assets is made without the need to go down the formal route of setting up a trust. S.620 ITTOIA 2005 defines a 'settlement' as any, “disposition, trust, covenant, agreement, arrangement or transfer of assets”.


A simple transfer of assets between persons could therefore be regarded as an arrangement as defined by S.620 ITTOIA 2005 thereby falling within the settlements legislation. Furthermore, if either the spouse or the settlor can benefit from the property transferred then S.624 could apply to ensure that the settlor is taxed on the income they have assigned away.


A settlement requires two elements. Firstly, there must be an arrangement, either formal or informal and, secondly, there must be an element of someone giving something away for nothing, ie a gratuitous intent.


Who is vulnerable to the settlements legislation?


HMRC seek to challenge arrangements under which an individual seeks to divert income to members of their family. Typically such family members will be spouses/civil partners and/or children who pay income tax at a lower rate than the individual themselves. Such “arrangements” usually involve a partnership or family company where profits are allocated to family members with the intention of reducing the overall tax burden.


For the purposes of the legislation, a child means:


  • a child or step-child of the settlor, or a child of their civil partner, who is:
  • under 18 years of age, and
  • neither married nor in a civil partnership



Mr Partridge runs a small company. He has the technical expertise and this generates the profits of the company. Mr Partridge owns 50% of the shares and his wife the other 50% but Mrs Partridge has no technical expertise in the area of the business and does not help in generating income. She also pays tax at a lower rate than her husband. Profits are distributed via dividends thereby ensuring that the tax burden is minimised.


Prior to 2007 this was the classic scenario that HMRC sought to attack.


HMRC has said that, “ a good test of whether or not the legislation could apply is to consider  would the same payments be made to a person who acquired shares in the company at arm's length, or is income being paid simply because the recipient is your spouse or child or some other individual you might wish to benefit.”


Exception for outright gifts


S.626 ITTOIA 2005 exempts an outright gift of assets between spouses/civil partners provided that:


  1. the gift is unconditional;
  2. the gift carries a right to the whole of the income; and
  3. the gifted property is not substantially a right to income.

Tax planning involving a wife gifting, say, a rental property to her husband to ensure that the rental income is taxed in her husband's name and uses his personal allowances etc, is still acceptable tax planning and will not be caught by s.624 provided the gift is outright and unconditional, ie, the husband is free to use the income and/or dispose of the property as he sees fit.


In Young v Pearce (1996), the directors of a company, Mr Pearce and Mr Scrutton, equally owned the ordinary voting shares. They subsequently arranged for preference shares in the company to be issued to their wives who did not work for the company. The company then declared substantial dividends to the holders of the preference shares. HMRC argued that the transactions amounted to “arrangements” and therefore constituted a settlement in which the settlors and their spouses had an interest. The Courts agreed as the gift of preference shares was a gift of “wholly or substantially a right to income” . The dividends paid to the wives were therefore taxed on the husbands as settlors.


Arctic Systems Ltd (HL 2007)


HMRC's interpretation and approach in applying the settlements legislation to businesses was tested in the case of Jones v Garnett. The facts in this case are straightforward and commonplace.


Mr Jones was an IT consultant operating his own computer consultancy business via a limited company called Arctic Systems Ltd. His decision to incorporate was a commercial one rather than being motivated by tax efficiency.


The company had an issued share capital of £2 which Mr Jones and his wife subscribed equally.


Mr Jones was the sole director and it was he who generated the income of the company. In contrast, Mrs Jones was the company secretary who performed administrative duties such as invoicing and bookkeeping. She worked, on average, about 5 hours a week for which she was paid a modest salary. The balance of any profits was distributed to the Jones's as dividend.


HMRC argued that this was a bounteous arrangement and that the settlement rules should be applied so as to tax the dividends received by Mrs Jones on her husband.


The Lords found in favour of the taxpayer concluding that:


  1. There was an arrangement in the nature of a settlement when the Jones's subscribed £1 each for their shares in Arctic Systems Ltd. 



  1. The exemption for gifts between spouses  applied and the dividends paid  to Mrs Jones should not be treated as income arising under the settlement and rightfully taxed on her. 

Dividend waivers


Where a close company declares a dividend and one or more of the shareholders waives the dividend in circumstances where other shareholders may benefit, there may be an 'arrangement' where the settlements legislation could apply. In such cases, HMRC will argue that the person making the waiver has indirectly provided funds for an 'arrangement' or 'settlement' by giving up a sum to which he or she is, or may become, entitled.



Where the person benefiting under the arrangement is not a spouse, civil partner or minor child the settlements legislation will not apply unless there are arrangements under which the money will be paid, or used to benefit the settlor (or spouse etc).


Example 1:


Mr and Mrs H owns 20 and 80 ordinary shares in H Ltd respectively. In 2010. the company made a profit of £25,000. Mrs H waived her right to any dividend. The company then declared a dividend of £1,000 per share and as a consequence, Mr H received a dividend of £20,000. Clearly a dividend of this amount could not have been paid from the company's profits on all the shares, so the waiver arrangement enhanced the dividend paid to Mr H. £16,000 (£20,000 x 80/100) of the dividend paid to Mr H is attributed to Mrs H under s.624 because the waiver was a bounteous arrangement.


No property has been transferred so the settlement is one of income. As such, the exemption for outright gifts to spouses does not apply.


Example 2:


Mrs T owns 80 'A' shares and Mr T owns 20 'B' shares in T Ltd. Both A and B shares rank equally. The company made a profit of £25,000 in 2010 and a dividend of £20,000 is voted on the B shares while no dividend is voted on the A shares. Clearly by not voting dividends on the A shares this is a bounteous arrangement as the dividend paid on the B shares could only be paid if no dividend was declared in respect of the A shares. £16,000 of the dividend paid to Mr T is attributed to Mrs T under s.624 because the decision only to vote dividends on certain shares was a bounteous arrangement.


Partnerships between spouses


If spouses are in partnership and one of the partners receives a disproportionate return on their contribution simply because they are a family member, s.624 could apply.


Example 1


Mr Monk is a self-employed architect. He has annual trading profits of £100,000. Mrs Monk (his wife) works as a part time secretary in the business earning £10,000 p.a.


As this is a normal commercial arrangement it will not be challenged by HMRC. Mrs Monk's salary uses up her personal allowance and some of her basic rate band. Her salary is also deductible in computing Mr Monk's trading profits.


Example 2


Mr and Mrs Monk are advised to establish a partnership and allocate profits 50:50. This will enable some of Mr Monk's profits to be diverted to his wife to use the rest of her basic rate band, rather than these profits being solely taxed on Mr Monk at higher rates.


This situation would be attacked by HMRC as a “bounteous arrangement” falling within s.624. If it were not for the fact that Mrs Monk was Mr Monk's wife he would not allow a part-time secretary in his business to have a 50% partnership share. Mrs Monk's partnership profits would therefore be taxed on Mr Monk as the settlor.


Partners who are also family members and who can justify their share of profits by virtue of their roles within the business or capital they have invested should not be caught by the legislation.




Relying on Arctic Systems


Husband and wife companies that involve similar or identical arrangements to those featured in the Arctic Systems case can rely on that judgement and HMRC will not be able to touch them. The shares held however must be ordinary shares as they attach a number of rights and provide much more than a right to income. 


Preference shares or ordinary shares that confer differing rights will be vulnerable to a challenge under the settlements legislation as will unjustified dividend waivers.


By all means carry on providing the traditional sound advice to your husband and wife businesses but remember the potential pitfalls and most importantly make your clients aware of these before they act upon your advice.


Qdos Contractor
Written by
Qdos Contractor
Award-winning providers of insurance for the self-employed, Qdos are the leading authority on IR35, offering industry-leading employment status services to ensure the flexible working industry thrive. Qdos are the Best Contractor Insurance Provider 2022 and won the Queen’s Award for Enterprise in Innovation 2022 and 2017. 

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