Ramifications Of Section 660 Decision ‘Greatly Exaggerated’ Says Judge

by Robert Lee, Tax-News.com, London

27 May 2005

In his judgment on the Arctic Systems case which was released earlier this week, Mr Justice Park stated that fears over the number of small family firms that will be affected by the Section 660 settlements legislation have been "greatly exaggerated", although it has emerged that low-asset backed service firms have become the main target of the taxman's clampdown.

In what was described as a "bitter blow" to potentially hundreds of thousands of small firms in the UK, the High Court last month rejected an appeal against the Inland Revenue's interpretation of Section 660, which was brought by the owners of a small IT firm, Arctic Systems.

Geoff and Diana Jones, the firm's owners, were contesting a £42,000 bill for back tax resulting from the Inland Revenue’s interpretation of the settlements legislation which sought to prevent the husband and wife-run firm from reducing their tax bill by allocating income to the less active partner, who pays tax at a lower rate.

"The decision of the Special Commissioners in this case has attracted considerable attention among professional tax advisers. It seems to have caused much consternation," Justice Park observed in his concluding remarks.

However, he went on to add that:

"In my view apprehensions that almost every case of a husband and wife company is going to be affected by this case are greatly exaggerated."

"If a husband and wife set up a joint company and run it together (for example, the company opens a shop and the couple run and staff it), it does not follow from my judgment in this case that the husband is going to be taxed on the wife's dividends."

"It is also an important feature of this case that Mr Jones provided funds directly or indirectly for the purposes of the settlement by working for Arctic Systems Limited in return for a salary far below his true earning power."

"It would be far harder for the Revenue to establish that there is a settlement or arrangement of which a husband is a 'settlor' if he is paid the going rate for employees carrying out the sort of work which he does."

"I have given judgment at some length because there is widespread professional interest in this case, but I do not think that there is anything particularly novel or alarming in my decision. I believe that it is a simple application of well-established principles. Applying those principles, I dismiss the appeal."

Mr Jones generated £91,000 in fees in the tax year investigated by the Inland Revenue, but only paid himself around £7,000 in salary, distributing the rest as a dividend split between himself and his wife, who owned a half share in the company. Accountants say that had Mr Jones paid himself significantly more in the form of a salary, say £60,000, the Revenue would not have taken up the case. Just what constitutes a "going rate" salary for owners of such firms is, for the moment, something of a grey area.

Just how many firms will be affected by the judgment is also open to debate. Originally, accountants feared that a wide ranging decision could have hit as many as 200,000 small firms. However, Justice Park made clear that businesses that own significant assets, such as stock, will not fall foul of the settlements legislation, meaning that substantially fewer companies are likely to hauled over the coals by the tax man than at first anticipated. Still, some tax experts contend that the Revenue's estimate of 30,000 affected firms is too low.

Following delivery of the judgment, it would appear that the tax man will be mainly targeting low-asset backed service companies such as consultants and freelance writers and, according to the Daily Telegraph, the Revenue already has approximately 100 firms and partnerships across a range of industries in its sights.

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