Spc00720

INCOME TAX – Settlement – Company owned by husband and wife – Allotment of shares in company to their minor children on subscription at par – Payment of dividends to children – Whether settlement by virtue or in consequence of which dividends were paid within meaning of Income and Corporation Taxes Act 1988 ss. 660A(1) and 660G(1) – Yes – Appeal dismissed
ASSESSMENT – Extended time limits – Negligent conduct – Husband and wife owned all shares in company – Husband and wife allowed minor children to subscribe for shares at par – Dividends paid to daughters – Whether husband and wife were negligent in omitting daughters’ dividends as dividend income of husband and wife in their tax returns – No 

THE SPECIAL COMMISSIONERS

	MR P A & MRS F J BIRD	Appellants

-	and –

	THE COMMISSIONERS FOR HER MAJESTY’S REVENUE & CUSTOMS 	 Respondents

				Special Commissioner:  SIR STEPHEN OLIVER QC

Sitting in public in London on 24 September 2008

No representation for the Appellants 

Rupert Baldry, counsel, instructed by the general counsel and solicitor to HM Revenue and Customs, for the Respondents

© CROWN COPYRIGHT 2008

DECISION

1.	Mr P A Bird and Mrs F J Bird appeal against amendments to self-assessments.  The principal issue in the appeals is whether dividend income received by their three minor daughters was income arising under a settlement within the meaning of the income tax “Taxation of Settlor” provisions in Part XV of Income and Corporation Taxes Act 1988 (“the Act”).

2.	Specifically Mr Bird and Mrs Bird appeal against amendments to self-assessments pursuant to section 28A(1) and (2) Taxes Management Act 1970 (“TMA”) in respect of their self-assessment tax returns for the two years ended 5 April 2001 and against amendments to their self-assessments pursuant to section 29 TMA in respect of their self-assessment tax returns for the two years ended 5 April 1999.  Mr Bird and Mrs Bird also appeal against extended time limit assessments to income tax pursuant to section 36 TMA for the three years ended 5 April 1998; those three assessments, additionally, raise the second issue which is whether there has been a loss of tax attributable to negligent conduct on the parts of Mr and Mrs Bird.

3.	The day before the hearing the solicitors acting for Mr Bird and Mrs Bird informed the Tribunal that no one would attend to present their cases.  Rule 16(2) of the Special Commissioners Rules enables the Tribunal to go ahead and hear an appeal in the absence of a party.  I decided to go ahead and to rely on the facts (i) as presented by HMRC on the basis of the agreed bundle documents, (ii) as set out in an agreed Statement of Facts and (iii) on the narrative accounts of what had happened in letters written by the advisers to Mr and Mrs Bird to the extent that this information has not been in dispute.

The facts

4.	Cargoitem Ltd was incorporated in September 1994 to trade as a wholesaler of specialist kitchen furniture.  Its authorised share capital was £1,000 divided into 1,000 shares of £1 each.  Two subscriber shares were issued.  One such share was transferred to Mr Bird and the other to his wife, Mrs Bird.  The annual returns for the period to 30 November 1995 show Mr Bird as the sole director and Mr Bird and Mrs Bird as joint company secretaries.  The agreed Statement of Facts states that Mr Bird and Mrs Bird were the original directors with Mr Bird as company secretary.  (The disparity is of no consequence in this appeal.) 

5.	Cargoitem through the exertions of Mr Bird and Mrs Bird embarked on its trade of selling kitchen components that it had imported from Spain. By the start of 1995 it was ready to expand.  It had difficulty in raising funds. Some time on or before 9 February 1995 Cargoitem borrowed £60,000 from its bank secured by way of a second charge over the Birds’ home.

6.	Late in December 1994 Mr Bird’s father died.  He left his estate to such of the Birds’ three daughters as should reach 18 in equal shares.  The eldest daughter was 15 at the start of 1995; the other twin daughters were then 10.  Mr Bird was the sole executor under his father’s will.  

7.	Mr Bird transferred £7,000 from the estate to Cargoitem on 22 March 1995 as an unsecured loan with interest of 2% over Bank of England base rate.  On 3 May 1995 a further payment of £54,364 was made to Cargoitem; this, says the Statement of Facts, was “characterised by the company as an unsecured loan from the minor beneficiaries to the company”. The accounts indicate that that loan remained outstanding for at least two years. 

8.	On 4 April 1995 Cargoitem issued a further 98 ordinary shares at par.  19 of these were issued to each of Mr Bird and Mrs Bird and 20 were issued to each of the three daughters.  There is no evidence as to whose money the daughters used to pay the subscription monies of £1 per share.

9.	Cargoitem carried on its trade profitably and in each year to 2002, when it ceased business, dividends were paid to the shareholders including the three daughters.  

The arguments on the main issue

10.	On those facts, argued Rupert Baldry for HMRC, the dividends paid to the three daughters (until they each reached 18, which the eldest did on 13 July 1998) constituted income arising under a “settlement” within the meaning of that word in section 660G.  In consequence the dividend income should be treated as that of Mr Bird and Mrs Bird equally by virtue of section 660B(1) of the Act.  The steps taken to make each of the three daughters a 20% shareholder in Cargoitem amounted, say HMRC, to an “arrangement” within the statutory definition of  “settlement”.  

11.	The case for Mr Bird and Mrs Bird as presented in the correspondence was that the daughters’ acquisitions of their shares had been part of a purely commercial transaction.  The shares had been a form of quid pro quo for a loan or loans which the daughters should be regarded as having made to Cargoitem.  

The legislation

12.	The relevant legislation is set out in the Appendix to this decision.  

Conclusions

13.	Before addressing the principal legal issue, I need to draw certain conclusions from the primary facts as set out above. 

14.	Until the shares, giving 60% of the equity in Cargoitem to the three daughters, were issued on 4 April 1995, the company and all entitlement and expectation of profit belonged to Mr Bird and Mrs Bird.  Those expectations were based on Cargoitem’s business that had already been running for some months before those share issues.

15.	The issues of shares to the daughters were not some form of consideration for the loans from Mr Bird’s father’s estate.  The £7,000 paid from the estate to Cargoitem on 22 March 1995 was regarded as a loan at interest.  There was no evidence that it carried the right to an issue at par of shares amounting to a 60% equity stake in the company.  There is no evidence of any connection between the £7,000 loan and the share issue.  The share issue documentation says nothing about the share issues being related to the daughters’ interests as loan creditors.  If the shares issued had related to the £7,000 loan, why were shares issued to Mr Bird and Mrs Bird as well?  The second loan of £54,364 was introduced a month after the share issue; there is no evidence to link that loan to the issue of shares to the daughters.    

16.	The effect of the share issues of 4 April 1995 therefore was that each daughter’s subscription of £20 gave her a 20% interest in Cargoitem at the expense of Mr Bird and Mrs Bird whose 50% equity holdings were consequently reduced to 20% equity holdings.  

Conclusion on the main issue

17.	Are the assessments, in the light of the facts and inferences summarised above, within the scope of the taxation of settlor provisions?  I start with the legislative purpose of those provisions.  Lord Wilberforce in IRC v Plummer [1980] AC 896 said of those provisions (at 812D-F) that they were – 

“… designed to bring within the net of taxation dispositions of various kinds, in favour of a settlor’s spouse, or children, or of charities, cases, in popular terminology, in which a taxpayer gives away a portion of his income, or of his assets, to such persons, or for such periods, or subject to such conditions, that Parliament considers it right to continue to treat such income, or income of the assets, as still the settlor’s income”.

18.	The provisions (recently revisited by the House of Lords in Jones v Garnett [2007] 1 WLR 2030) deal, within certain defined limitations (one of which was present in the Jones v Garnett circumstances), with various kinds of arrangements under which a taxpayer seeks to save tax by diverting income to someone who pays tax at a lower rate, or not at all.  Where the provisions apply, they treat the income arsing under the settlement as income of the “settlor” so that it is charged to tax as if it were his income and not the income of the person to whom it actually belongs.

19.	The use of a corporate structure to provide an income stream to a minor child, thereby reducing higher rates of tax is a typical situation where the taxation of settlor legislation can and does apply.  See Copeman v Coleman (1939) 22 TC 594 and Butler v Wildin (1988) 61 TC 666.  The latter is comparable to the situation here where Mr and Mrs Bird have conferred on their three minor daughters a 60% stake in the equity of Cargoitem and consequently provided the daughters with dividend rights.  

20.	“Arrangement” has the ordinary meaning of “a structure or combination of things for a purpose” (the shorter Oxford English Dictionary) or “a number of objects arranged or combined in a particular way” (New SOED). 

21.	In Jones v Garnett the House of Lords endorsed the broad concept of “arrangement” as developed in the earlier line of cases from IRC v Payne 23 TC 610 to Butler v Wildin supra.  These cases make it clear that there is no need for any formal legal trust or settlement for these provisions to apply.  The cases are also authority for the proposition that a definite plan (including a relatively simple plan), to use a company’s shares to divert income, falls within the meaning of an arrangement: see paragraphs 48-49 per Lord Walker.  In this connection it will be noted that Lord Hoffman expressly approved the “realistic view” that the Court should take of the matter: see paragraph 11.

22.	Sir Wilfred Greene MR in IRC v Payne supra observed at page 66 that the whole of what was done should be looked at in determining whether an arrangement existed.  For this purpose a person’s placing himself into a relationship with the company as part of deliberate scheme to bring about a desired result might constitute such an arrangement: see page 626.  Moreover, a number of elements may , as the SOED definition indicates, be taken together to form a single “arrangement”.  An example of this is Butler v Wildin supra, a case which has strong parallels to the present.  

23.	In the present case, Mr Bird and Mrs Bird arranged for their minor daughters to take the 60% share in Cargoitem thereby enabling the three children to share in the profits of the business that Mr and Mrs Bird had previously owned between them.  It seems to me that in so doing Mr and Mrs Bird made an arrangement within the scope of the settlement provisions.  That is the only analysis consistent with the authorities, including specifically Jones v Garnett, where the acquisition by Mrs Jones of her share in the company gave rise to an arrangement.  (In that case the settlement provisions were expressly excluded by the exemption for outright gifts between spouses; but that exemption has no application here.)

24.	For an arrangement to constitute a settlement for purposes of the taxation of settlor provisions, there has to have been an element of “bounty”. On the question of  “bounty” I follow Lord Hoffman’s approach in Jones v Garnett.  In determining whether it amounts to an arrangement it is necessary to ask whether the appellant in question would have entered into it with someone with whom he was dealing at arms length?  (See per Lord Hoffman at paragraphs 23-24 and Lord Walker at paragraph 55).

25.	In this connection the argument presented on paper by the representatives for Mr and Mrs Bird has been that the minor daughters’ acquisitions of shares had been part of a purely commercial transaction, the shares being seen as some kind of quid pro quo for a loan which, it is said, the children made to Cargoitem.  That, in my view and in the light of the fact summarised above, is not sustainable.  The minor daughters did not take part in any commercial transaction.  The reality of the arrangements by which money was transferred from Mr Bird’s father’s estate to Cargoitem is that Mr Bird, while still executor of his father’s will, arranged for monies owned prospectively by the three daughters (and contingent on reaching the age of 18) to be paid by way of a “loan” to Cargoitem.  The risk involved in that transaction accrued to Mr Bird personally rather than to the children.  Mr and Mrs Bird then arranged for the children to take a 60% share in Cargoitem to enable 60% of the profits to flow to the three daughters.  That arrangement was at the expense of their existing equity interest in Cargoitem.  That transaction cannot in my view by regarded as an arms length arrangement.  There was, therefore, the necessary element of bounty to bring the arrangements within the scope of the expression “settlement”.

26.	For those reasons I conclude that the income arising to the three minor children (while each was a minor) is properly chargeable as the income of Mr and Mrs Bird under the taxation of settlor provisions.

Extended Time Limit (“ETL”) Assessments 

27.	The assessments on Mr and Mrs Bird for 1995/96, 1996/97 and 1997/98 relate to income that arose outside the ordinary time limit.  Section 36 of TMA enables HMRC to make ETL assessments where the taxpayer, known as “the person in default”, has caused the loss of tax attributable to his fraudulent or negligent conduct or the fraudulent or negligent conduct of a person acting on his behalf.  HMRC see the failure of Mr and Mrs Bird to return as their income the dividends paid to the three minor daughters during those years as “negligent conduct”.

28.	I approach this problem by asking what the reasonable compliant taxpayer who had been a party to, and had the same degree of knowledge of, a transaction on lines similar to those summarised above, would have entered in his return.  

29.	The only relevant box in the 1995 Tax Return was headed “Trusts and Estates”.  The subheading to the box which, say HMRC, should have contained the minor daughters’ dividends from Cargoitem is headed “Income and Capital from settlements for which you have provided funds”.

30.	Standing alone, those headings do not appropriately describe the daughters’ dividends.  However a note at the side of the subheading says, - “Income and Capital will be treated as yours if certain conditions apply; see Note 34”.

31.	Note 34 of  “11 P (1995)” reads, so far as is relevant:

 “A settlement includes not only a formal trust, but also an agreement, covenant, disposition, arrangement or transfer of assets.  If you have directly or indirectly provided funds for a settlement, the income of that settlement will usually be treated as yours if … capital or income from the settlement benefits your own unmarried child or stepchild and the child is under 18”.

32.	Mr Bird and Mrs Bird entered the dividends they received from Cargoitem in the “UK dividends” box.  They did not enter their minor daughters’ dividends from Cargoitem in the “Income and Capital from settlements for which you have provided funds box”.  If those words stood alone (and before turning to Note 34), the assumed reasonable compliant taxpayer would not be expected to enter the minor daughters’ dividends in that box.  There was no “Settlement” in the ordinary meaning of  “Trust and Estate” from or of which those dividends were income.  How then should the assumed reasonable compliant taxpayer have reacted to the words of  “Note 34”? 

33.	Before answering this, there are some preliminary points to make.  First, the initial year of the daughters’ dividends (1995/96 Return) is critical.  That is the time when the issue of whether those dividends should have been returned as Mr and/or Mrs Bird’s income should have been addressed.  The pre-self assessment return form was sent out with the 11P 1995 pamphlet which contains Note 34.  The wording has not changed in later years of the pre-self assessment regime.  That wording is substantially carried over to the Notes relating to boxes 7.1 to 7.3 of the Trust Return under the self assessment regime. But a taxpayer is not sent a Trust Return unless one is either sent out to him with his original package or he asks for one by ticking the “Yes” box relating to Question 7, i.e. “did you receive any income from any Settlement or Estate of a deceased person?”  At that stage, there is no explanation as to the wider meaning of “settlement”.

34.	Second, the transaction by which the shares in Cargoitem were issued to the daughters had been carried out with the advice of Cargoitem’s accountants.  The tax accountant with responsibility for Mr and Mrs Bird’s tax returns did not know that those actions had taken place.  When the standard yearly questionnaire was sent out by the tax accountant to Mr and Mrs Bird prior to the making of the tax return, nothing was entered on it that indicated the presence of any “Settlement” in relation to the Cargoitem shares.  I do not think therefore that, even if there had been negligent conduct on the part of Mr or Mrs Bird, there was negligent conduct of the person acting on their behalf.  

35.	Third, each daughter subscribed £20 for her holding of 20 £1 shares.  HMRC, on whom the burden of providing negligent conduct lies, has not claimed, or indeed put in any evidence to show, that that money came from Mr and/or Mrs Bird.

36.	Fourth, the assumed reasonable compliant taxpayer should be expected to read the notes to the return.  In the present case he or she should read Note 34.  

37.	This brings me to the words of Note 34, i.e. “if you have directly or indirectly provided funds for a settlement, income of that settlement will usually be treated as yours if…” Those words follow the statement that a settlement will include “not only a formal trust, …but also… an arrangement.” Would the assumed reasonable compliant taxpayer in a similar position to that in which Mr and Mrs Bird found themselves have concluded that he had indirectly provided funds for the purpose of the arrangements that included the payment of the dividend?  The assumed taxpayer might look into the Shorter Oxford English Dictionary which gives, as the main definition of “funds”, the expression “pecuniary resources”.  No sum or sums of money were introduced into the arrangement by Mr and Mrs Bird.  The thing that was provided to each daughter was the opportunity of participating in dividends and capital growth in Cargoitem.  While that advantage may have been conferred on the minor daughters at the expense of Mr and Mrs Bird, I do not think that the reasonable compliant taxpayer would recognise it as a situation in which he had indirectly provided “funds” for the purposes of the arrangement.  He would, I think, see the funds as profits out of which the dividends were paid.  He would see Cargoitem’s share issue of 4 April 1995 as one designed to enable the three daughters to subscribe and so to spread the ownership of Cargoitem around the family.  But it would require a high level of constructive reasoning to recognise that transaction as the provision of funds for the arrangement.  It would demand a sophistication that is beyond what is expected of the assumed reasonable competent taxpayer.

38.	For that reason I do not think there has been “negligent conduct” such that extended time limit assessments may be made on Mr and Mrs Bird.  This conclusion is equally applicable if any of the ETL years came with the self-assessment regime.

Costs

39.	HMRC asked for their costs on the basis that Mr and Mrs Bird have acted wholly unreasonably in relation to the appeal.  Specifically, it is said, HMRC has incurred costs in attending the hearing, being costs which would not have been incurred had they known that either the Birds of their advisers were going to attend.  

40.	In all circumstances I do not think it would be appropriate to make a costs order against Mr and Mrs Bird.  The matter had to come to the Tribunal to enable the facts and the legal arguments to be presented.  I would not have given a decision without the benefit of oral argument.  I cannot see, therefore, that a last minute decision by Mr and Mrs Bird not to attend (and not to have any representation at the hearing) was wholly unreasonable.  

41.	Nor can I see that any additional significant costs have been incurred by HMRC as the result of the unexpected absence of Mr and Mrs Bird and their advisers.  Further, in view of my decision against HMRC on the ETL point, I think it would inappropriate to make a costs award against Mr and Mrs Bird.

SIR STEPHEN OLIVER QC
SPECIAL COMMISSIONER

RELEASED: 3 November 2008
SC 3008/2008

APPENDIX 

THE LEGISLATION

3.	The relevant statutory provisions of Part XV of the Taxes Act are as follows :

	Section 660A (1)

 “Income arising under a settlement during the life of the settlor shall be treated for all purposes of the Income Tax Acts as the income of the settlor and not as the income of any other person unless the income arises from property in which the settlor has no interest”

Section 660A(2)

“… a settlor shall be regarded as having an interest in property if that property or any derived property is, or will or may become, payable to or applicable for the benefit of the settlor or his spouse in any circumstances whatsoever.”

Section 660A (6)

“The reference in subsection (1) above to a settlement does not include an outright gift by one spouse to the other of property from which income arises, unless –

	(a)	the gift does not carry a right to the whole of that income, 		or
	(b)	the property given is wholly or substantially a right to 			income.

For this purpose a gift is not an outright gift if it is subject to conditions, or if the property given or any derived property is or will or may become, in any circumstances whatsoever, payable to or applicable for the benefit of the donor”.

Section 660A (10)

“In this section “derived property”, in relation to any property, means income from that property or any other property directly or indirectly representing proceeds of, or income from, that property or income therefrom”.

For 1994/95, the predecessor provisions of Part XV applied (s. 663 ICTA); the definition of “settlement” was materially the same (s. 670).

Section 660B (1)

“Income arising under a settlement which does not fall to be treated as income of the settlor under section 660A but which during the life of the settlor.

	(a)	is paid to or for the benefit of an unmarried minor child of
		the settlor, or
	(b)	would otherwise be treated (apart from this section) as income		of an unmarried child of the settlor

in any year of assessment shall be treated for all the purposes of the Income Tax Act as the income of the settlor for that year and not as the income of any other person”.

Section 660B (6)

“In this section – 
	
	(a)	“child” includes a stepchild and an illegitimate;
	(b)	“minor” means a person under the age of 18 years, and
		“minor child” shall be construed accordingly; and 
	(c)	references to payments include payments in money or
		money’s worth”.

Section 660G (1)

“In this Chapter –

	“settlement” includes any disposition, trust, covenant, agreement, 	arrangement or transfer of assets, and 

	“settlor”, in relation to a settlement, means any person by whom the 	settlement was made”

Section 660G (2)

	“A person shall be deemed for the purpose of this Chapter to have 	made a settlement if he has made or entered into the settlement directly 	or indirectly, and, in particular, but without prejudice to the generality 	of the preceding words, if he has provided or undertaken to provide 	funds directly or indirectly for the purpose of the settlement…”