Critical analysis of House of Lords decision in Jones (Respondent) v. Garnett (Her Majesty's Inspector of Taxes) (Appellant)This controversial case relates to the taxability of profits of a corporate business owned by husband and wife. Mr Jones an ex-Information Technology (IT) expert employee set up his own business in 1992 in the form of a limited company soon after his employment ended. He and his wife formed the company with one share each at the face value of £1 per share. The limited company was named Arctic systems. While Mr Jones was the director, his wife was the secretary.
Though there was no agreement as such, he was acting as a director as well as an employee of the company. The company purported to provide Mr Jones services to clients through agents for fees. Mrs Jones just worked for the company without earning anything for the company on her own. Her work consisted of book-keeping, liaising with accountants, coordinating with the bank of the company, taking out insurance, preparation of VAT returns, making tax payments for the company, billing for the company, certifying accounts of the company as its secretary, discussing company contracts with Mr Jones, attending to telephone calls and sending resumes, all consuming about four to five hours of work per week.
The company received large sums of money by way of fees for services rendered by Mr Jones to its clients. Both husband and wife took small salaries as employees. After deducting the company expenditure including their salaries, corporate tax on the net profit was also paid by the company. The remaining profit after taxation was disbursed as dividends to them by the company.
The tax authorities found this as a means to circumvent payment of higher taxes. It was argued by them that while Mrs Jones claimed more than proportionate salary for her limited number of hours of works hardly five per week, Mr Jones took very little salary for the kind of work he provided. And that had he taken more salary, dividends would have been lesser than what had been paid. (Martin) This practice was found out in 2004 by Internal Revenue’s investigation which led to a demand for payment of an extra £ 42,000 as tax invoking section 660A of settlement legislation covering tax liability for six years as a result of purported tax avoidance measure by declaring higher dividends, though the demand was later reduced to £ 6,000 after negotiations.
The parties therefore preferred an appeal before the Revenue Special Commissioners with the help of Professional Contractors Group (PCG) (Arctic Systems case)Section 660 A is known as settlements legislation as old as 1930 dealing with cases of attempted avoidance of tax by way giving gifts such as shares through ‘settlement’ with a view to prevent tax payers from transferring sizeable sum of profits on another person who would pay lesser tax than what would have been payable by him had he not transferred.
. The tax payer by way of forming a company takes lesser salary so as to avoid higher premiums on National Insurance and disburse balance profits in the form of dividends to share holders including himself. Besides, he also splits his potential dividend between himself and his wife so that tax attracted by dividends at a lesser slab also is proportionately less.
This is what is being trying to be stifled by the Inland Revenue by way of Settlements Legislation. Section 660A would apply if spouse is also given shares in the company along with husband or wife as the case may be though not active or not an expert in the line of activity of the relative business of the corporate company warranting a higher salary or dividends. It would not be applied if spouse does not own any share in the company or if the spouse also contributes equal amount of expertise and brings in income as the other spouse (Arctic Systems Case)