Reply to: appointing parents as shareholders in limited company

[TheFaQQer]

I reserve my right to change my opinion in the light of any future developments/law changes/HMRC cases.

HMRC don't even treat Arctic as a test case, so nothing is absolutely settled.

[TheCyclingProgrammer]

I think there are two reasons for this.. a) as you say, HMRC may not challenge where there is no apparent benefit for the settlor and b) I would imagine many are clear cut in HMRC's favour, i.e. where the person holding the shares is seeing none of the income!

Well I'm sure you have a better picture of this than us non-accountants. I guess some people will try anything. But just because some people clearly try it on, I don't think everybody should have to get too worried about this. Just don't wave giant red flags in HMRCs face (HMRC helpfully list the red flags in their settlements guidance booklet).

It kind of reinforces my point...if you aren't doing anything seriously dodgy, you probably have very little to worry about. Why *would* HMRC try and pursue a case which would require some serious legal wrangling and court challenges to make stick if there are plenty of blatant easily won cases for them to pursue? It would require a hefty sum of tax and the opportunity to set a precedent in their favour to make them want to do it, don't you think?

Anyway, I appreciate the friendly debate.

I recall one client that joined us from a small high street practice a few years ago. We asked about the second shareholder and it turned out to be the son of a friend who lived next door. The son was at university so they thought it would be ok to use up his allowances!

Amazing.

Out of curiosity, how did you rectify that "situation"? Close the company and hope for the best?

[Martin at NixonWilliams]

The "benefitting from the arrangement" angle hasn't really been tested

I think there are two reasons for this.. a) as you say, HMRC may not challenge where there is no apparent benefit for the settlor and b) I would imagine many are clear cut in HMRC's favour, i.e. where the person holding the shares is seeing none of the income!

I recall one client that joined us from a small high street practice a few years ago. We asked about the second shareholder and it turned out to be the son of a friend who lived next door. The son was at university so they thought it would be ok to use up his allowances!

[TheCyclingProgrammer]

I am not sure how much use this is but there is the spirit of the rule to consider. We had a post ages ago where someone made the point that it wasn't unreasonable for his partner to enjoy some of the results of the business for supporting him/her while growing it. Kind of non-tangible work towards it which makes sense and seems pretty fair. I do believe this spirit is being heavily abused and wives just being used as tax mules so I also think it is still not safe from future legislation or aggressive tax avoidance rules but that is my uneducated opinion.

This is my thinking (and I think it applies to non-married partners too, although that obviously takes you out of the scope of the spouse exemption).

Maybe a measure of how fair/aggressive an arrangement is depends on the shareholding, but where do you draw the line? Is 50/50 reasonable when one person does most of the work. Is 75/25 in favour of the main earner fairer? I think most people would say that making the non-earner the majority shareholder is possibly taking the piss....

Doing this just to pass money to your parents or kids and avoid tax doesn't even begin to meet the spirit.

Maybe not. Its worth re-iterating that in the case of children, you don't need to look to the "spirit" of the law - the letter of the law is very clear in case of children. You just can't do it.

No idea how much impact this would have but who ever wrote the piece made a pretty interesting and sensible point. HMRC don't really do sensible so I guess it is back to the fine print.

My feeling is that if HMRC spot a case that falls so obviously within the scope of the legislation (e.g. children are involved, or you are doing dodgy things like constantly changing the shareholding and issuing dividend waivers) and the tax being avoided is significant, they will pursue it.

If on the other hand, its not clear cut that they will win or be able to set a good precedent, they won't bother.

As somebody who shares 25% of the proceeds of his company with his (non-married but soon to be married) partner, I obviously have a bias in my reasoning, which I accept. If I wasn't satisfied, I'd be looking at reversing the arrangement. But I really see little reason for most people to worry about this.

I reserve my right to change my opinion in the light of any future developments/law changes/HMRC cases.

[northernladuk]

I am not sure how much use this is but there is the spirit of the rule to consider. We had a post ages ago where someone made the point that it wasn't unreasonable for his partner to enjoy some of the results of the business for supporting him/her while growing it. Kind of non-tangible work towards it which makes sense and seems pretty fair. I do believe this spirit is being heavily abused and wives just being used as tax mules so I also think it is still not safe from future legislation or aggressive tax avoidance rules but that is my uneducated opinion.

Doing this just to pass money to your parents or kids and avoid tax doesn't even begin to meet the spirit.

No idea how much impact this would have but who ever wrote the piece made a pretty interesting and sensible point. HMRC don't really do sensible so I guess it is back to the fine print.

[TheCyclingProgrammer]

That we agree on!

I agree with your point but that doesn't change my opinion.

Consider Arctic Systems - Mr. Jones was diverting his income to make use of his wife's allowances. As a result, Mr. Jones was making a significant tax saving and, between them, they had a much higher joint income than they would have had. My view is that he benefits from the arrangement.

If Mr. Jones is deemed to have a benefit, the legislation you have highlighted suggests this would not meet the criteria required to make use of the spousal exemption but, as we all know, they did and they were succesful in defending the challenge.

Agreed. Likewise, you could say there are several other ways a settlor could potentially benefit from dividends paid to their wife (things like paying a joint mortgage, joint accounts etc.) that could potentially result in the spousal exemption from not applying, but the Arctic judgement makes this unlikely.

In fact, the general consensus appears to be: if you are married and you gift ordinary shares to your spouse, then you are safe, thanks to the outcome of the Arctic case. The "benefitting from the arrangement" angle hasn't really been tested and I don't think HMRC are particularly inclined to try it either, hence the governments aborted attempt at changing the law.

It just seems odd to me that, if the spousal exemption could be dismissed on the basis that a gift is not an outright gift due to the settlor benefitting in some way, that HMRC did not pursue this argument and instead relied entirely on the claim that the shares were nothing more than a right to income; an argument they ultimately lost.

Maybe they missed a trick. Maybe they were so focussed on one issue, that they overlooked another. Seems unlikely. Or perhaps they just thought the argument wouldn't fly and didn't bother.

[Martin at NixonWilliams]

I just don't think its as clear cut as some people think it is

That we agree on!

I agree with your point but that doesn't change my opinion.

Consider Arctic Systems - Mr. Jones was diverting his income to make use of his wife's allowances. As a result, Mr. Jones was making a significant tax saving and, between them, they had a much higher joint income than they would have had. My view is that he benefits from the arrangement.

If Mr. Jones is deemed to have a benefit, the legislation you have highlighted suggests this would not meet the criteria required to make use of the spousal exemption but, as we all know, they did and they were succesful in defending the challenge.

It is far from straightforward as you say, where the facts are not the same as Arctic Systems and have not been tested elsewhere, you could have a worthy opinion either way.

[TheCyclingProgrammer]

There is a retained interest if the property is being transferred for the benefit of the settlor. If the reason for the transfer is purely to save tax on the settlor, my view is that the settlor has a retained interest.

Then I would simply say this: if it was enough to say that the settlor has retained interest purely because they have benefitted from the saved tax, then that would mean anybody who has a similar arrangement with their spouse would also be caught by the legislation because the spouse exemption would no longer apply (except we know that this is not the case).

Emphasis mine:

626 Exception for outright gifts between spouses [F1or civil partners]

(1)The rule in section 624(1) does not apply in respect of an outright gift—
(a)of property from which income arises,
(b)made by one spouse to the other [F2or one civil partner to the other]F2 , and
(c)meeting conditions A and B.
(2)Condition A is that the gift carries a right to the whole of the income.
(3)Condition B is that the property is not wholly or substantially a right to income.
(4)A gift is not an outright gift for the purposes of this section if—
(a)it is subject to conditions, or
(b)there are any circumstances in which the property, or any related property—
(i)is payable to the giver,
(ii)is applicable for the benefit of the giver, or
(iii)will, or may become, so payable or applicable.
(5)“Related property” has the same meaning in this section as in section 625.

The spouse exemption above clearly states that it only applies in the cases of an outright gift. It then goes on to say that for a gift to be considered an outright gift, it must not be applicable for the benefit of the giver.

Compare this wording with the definition of "retained interest" under s625:

A settlor is treated for the purposes of section 624 as having an interest in property if there are any circumstances in which the property or any related property—
(a)is payable to the settlor or the settlor's spouse [F1or civil partner]F1 ,
(b)is applicable for the benefit of the settlor or the settlor's spouse [F1or civil partner]F1 , or
(c)will, or may, become so payable or applicable.

As you can see, they are almost identical, except s626 uses the word giver instead of settlor.

So aren't you effectively saying that if a person gives shares to their husband/wife and one of the underlying reasons behind this is to save tax, that the person is benefitting from the settlement and therefore the spouse exemption should not apply?

Hasn't the Arctic case already put this beyond doubt that this isn't the case? It seems to me that for HMRC, trying to prove retained interest is very hard except in very specific (and documented) circumstances. In fact, this has made me curious as to what the interpretation of this was in the context of the Arctic case - I'll have to go and look at the judgement again.

I'm still not saying that I definitely do not think the OP would be caught, I just don't think its as clear cut as some people think it is and that the chance of being investigated over this is increasingly small.

EDIT: had a re-read of some of the Arctic judgement and it seems that, having established that there was an element of bounty in the Jones' case, that the bountiful nature of the arrangement meant that HMRC could not argue that the gift was not an outright gift.

It was Mr Jones's consent to the transfer of a share with expectations of dividend to Mrs Jones for £1 which gave the transfer the "element of bounty" for the purposes of section 660A. By the same token, I think it made the transfer a "gift" for the purposes of subsection (6). And there is no dispute that, if it was a gift, it was outright.

http://www.publications.parliament.u...jones%20-1.htm

So here he says there is no question that it was an outright gift - the issue of whether it was payable to or applicable for the benefit of the giver ("donor" in the original 660A legislation) didn't even come up from what I can see. If HMRC believed the tax saving was enough that the donor/settlor had benefitted and therefore the exemption didn't apply, why didn't they press this issue?

[Martin at NixonWilliams]

Would you agree that if the OP had not been funding his parents living, then as long as the money went to his parents and he didn't get any of it back from them during their lifetime, that he probably would not be caught?

I wouldn't agree, I just think that the OP's situation makes this particular scenario clear cut.

There is a retained interest if the property is being transferred for the benefit of the settlor. If the reason for the transfer is purely to save tax on the settlor, my view is that the settlor has a retained interest.

There are elements other than retained interest that would be considered, namely is there a settlement? is there bounty? are the transferrer and transferee married? is it wholly or substantially a right to income?

All of the above would be considered together and, on balance, my view is that a case like this would normally lose.

Interpretation will always be key, but even if something seems black and white in the taxpayers favour, the court can still overrule if the outcome defeats the objective of what the legislation was designed to achieve.

Hopefully the government will eventually change the legislation as they said they would in 2007, rather than deferring it whilst we continue to debate!

[TheCyclingProgrammer]

Re-skimming Jones v Garnett, isn't part of the whole S660 (now Chapter 5, Part 5 of ITTOIA 2005) debate whether the settlement is a right to income?

Only in the cases of spouses I think. The right to income point is used in determining if the transfer is an outright gift and an outright gift is necessary for the exemption to apply.

I'm not sure it's relevant outside the scope if the spouse exemption (s626 I think).

[TheFaQQer]

Re-skimming Jones v Garnett, isn't part of the whole S660 (now Chapter 5, Part 5 of ITTOIA 2005) debate whether the settlement is a right to income?

[TheFaQQer]

So I would argue that if there are no dividend waivers, the shares are ordinary shares and gifted unconditionally, that dividends are paid directly to the parents, none of the money makes its way back to the OP and he derives no obvious benefits from the money, then he wouldn't be caught.

Therein lies the rub.

The obvious benefit that he is receiving from the money is that he doesn't have to pay anything out of his post-tax income.

[TheCyclingProgrammer]

The key part of the judgement from the special commissioner is that he took Hoffmann's interpretation of whether bounty had been applied - whether the arrangements would have been entered into if the transactions had been between individuals acting at arm’s length or not.

The issue of bounty is only used in determining whether or not a transaction constitutes a settlement within the scope of the legislation - it is not what determines if the settlement income is taxed on the settlor.

I don't think anybody is arguing that a gift of shares to family members would not be a bounteous arrangement. I'm not. Even in the Arctic Case, the arrangement would have been considered a settlement due to its bounteous nature if the spouse exemption had not applied.

As I say, the PCG article you reference gives you a reference to Bird v HMRC, which involved the gifting of shares to family members and HMRC argued there was a retained interest...and won.

Which involved gifting of shares to children which is explicitly legislated against in s629 (previously s660b) which I linked to in my previous post and which proved to be the deciding factor in the Bird case. There is no specific section for "family members".

So yes, definitely avoid creating a settlement on your children by giving them shares and dividends. This is most definitely a no-go area. But you can't simply extend this principle to "all family members".

[northernladuk]

It's not an unreasonable interpretation, but its just that, an interpretation.

I do understand a lot of this is down to interpretation but I cannot see for one minute how this particular can be interpreted any other way.,..

I bear the cost of their living after paying high 40% tax from my pocket, so why not let them benefit directly from ltd company after 20% corporation tax.

He clearly states he wants to pass the money form his company to avoid tax. In this case he has made it absolutely black and white what he wants to do and on that admittance alone he wouldn't stand a chance.

[TheFaQQer]

Which isn't surprising, given that settlements to children fall under an entirely different section of the law - s629, which itself was based on the old s660B.

Income Tax (Trading and Other Income) Act 2005

In this case, any settlements on relevant children of a settlor are automatically taxed on the settlor. There are no such provisions relating to "retained interest" in this situation.

So not really relevant in this particular case IMO.

I wish there was more information on the Ted case too, I'd like to read the judgement.

The key part of the judgement from the special commissioner is that he took Hoffmann's interpretation of whether bounty had been applied - whether the arrangements would have been entered into if the transactions had been between individuals acting at arm’s length or not.

Interestingly, the most recent case I could find reference to involved the gifting of shares to family members and HMRC argued there was a retained interest...and lost.

As I say, the PCG article you reference gives you a reference to Bird v HMRC, which involved the gifting of shares to family members and HMRC argued there was a retained interest...and won.