In a recent case, the Special Commissioners decided that a couple who allowed their three young daughters to acquire shares in the parents’ company at less than market value, should be taxable on dividends paid on the daughters’ shares.

The circumstances of the case were not straightforward, as the parents claimed (but failed to prove) that the share purchase was in some way linked to a loan made to the company but the facts appear to be:-

1. The parents set up a new company in which each subscribed £1 for one ordinary share.
2. Some months later, when the company was trading profitably, a further 98 ordinary shares were issued for £98 to both parents (19 shares each) and the three daughters (20 shares each).
3.  Each year until the company ceased trading, dividends were paid on the 100 issued shares.

Where children under 18 have income of more than £100 that stems from gifts from their parents, the income is treated for tax purposes as belonging to the parents.

In this case, the Special Commissioners decided that the parents had effectively gifted the right to dividends to their daughters (and would not have done the same for a third party) and that the income therefore belonged to the former.

Had the parents been able to show a commercial link between the loan and the issue of the shares, it is quite possible that the outcome would have been different. Yet further proof that documenting what you are doing – and why – is of paramount importance when dealing with the Revenue.

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Under the old rules, where an individual acquired shares on more than one date, the legislation specified which shares were treated as sold for CGT purposes on a part disposal. Shares were generally matched on a ‘last in, first out’ basis, (with exceptions for “bed and breakfasting” within 30 days).

As part of the simplification of CGT, the rules for disposals after 5 April 2008 have changed and could produce some unfortunate results. From that date the cost of all shares in any one company will be averaged.

Assuming an increasing share price over the period in which shares have been acquired, the taxable gain on the first disposals made after 5 April 2008 could be considerably higher than would have been the case under the previous legislation.

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Anyone thinking of exchanging shares in their trading company from loan notes in another company after 5 April 2008, will need to be very careful about which type of loan note they accept.

The rules are involved and every circumstance will differ.

If you would like to know more, please get in touch with Cathy Corns or me.

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Below is a brief update on the Arctic Systems case from Lisa Spearman, Mercer & Hole Partner and Tax Plus Blog contributor.

An announcement has been widely expected and commented on in this and other blogs following on from the Revenue’s defeat in the House of Lords. This is a case of the dog that didn’t bark or at least not yet.

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The House of Lords issued their judgement in the case of Jones v Garnett (also known as the “Arctic Systems Ltd” case) on 25 July 2007. To much rejoicing the case was decided in favour of Mr and Mrs Jones. However, the Revenue is a bad loser.

On 26 July a written Ministerial statement was issued by the Exchequer Secretary to the Treasury, announcing the intention to change the law.

Using the standard “the Government is committed to maintaining fairness in the tax system” statement the Government now believes it needs to do something to “ensure that there is greater clarity in the law regarding its position on the tax treatment of income splitting”. Actually, in my opinion, the law is now clear – it may not say what the Revenue wants it to, but that is unfortunate (for them) rather than unclear.

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The long awaited decision on Arctic Systems

This all seems to have been going on for so long you may need reminding of what all the fuss is about; so

- Mr and Mrs Jones ran a small IT company of which Mr Jones was the sole director. They each owned one share in the company took a small salary and extracted the majority of their required funds by way of dividend. These, of course, were paid in line with the shareholdings, on a 50:50 basis.

Nothing out of the ordinary there so what was the problem? It seems to be that Mr Jones paid tax at higher rates and Mrs Jones did not. HM Revenue & Customs (HMRC) argued that the settlements legislation should apply to the dividends paid to Mrs Jones such that they should actually be taxed (at the higher rate) on Mr Jones.

The Special Commissioners and the High Court (April 2005) agreed with HMRC, however the Court of Appeal (December 2005) rejected HMRC’s argument.

The result of all this is that there has been significant doubt about the correct tax treatment and obligations to report income and dividends in such circumstances.

The House of Lords unanimously decided in favour of the taxpayer. The key issue appears to be that an ordinary share is not “wholly … a right to income” and therefore the dividends are not caught by the settlements legislation.

This represents a resounding success for taxpayers and gives them back the right properly to plan their affairs in companies and partnerships.

If you were waiting for this judgement to instigate any planning or indeed need help on amending returns for earlier years, please contact any member of our tax team

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