[2010] UKFTT 334 (TC)

TC00619

Appeal number:  SC/3065/2009

DIRECT TAX – Husband & wife jointly fund share purchase – over 97% shares purchased transferred to husband- new class of shares allotted to wife – wife receives approximately 40% of dividends – whether settlement under s660A ICTA 88

FIRST-TIER TRIBUNAL

TAX 

	DAVID THOMAS PATMORE	Appellant

	- and -

	THE COMMISSIONERS FOR HER MAJESTY’S
	REVENUE AND CUSTOMS	Respondents

		TRIBUNAL: 	Barbara Mosedale (TRIBUNAL JUDGE)									
										
Sitting in public at 45 Bedford Square, London WC1 on 12 and 13 May 2010

Mr R McMorran, Chartered Certified Accountant,  for the Appellant

Mr R Baldry, Counsel,  instructed by the General Counsel and Solicitor to HM Revenue and Customs, for the Respondents

© CROWN COPYRIGHT 2010

DECISION

1.	Mr Patmore appeals against amendments to his tax returns as follows:
Year 1999/00 increase in tax due of £4,749.97
Year 2000/01 increase in tax due of £4,999.95
Year 2001/02 increase in tax due of £4,875.07
Year 2002/03 increase in tax due of £5,124.82
2.	The amendments were made by HMRC to bring into account dividend income of £21,111 paid in the year 1999/00, £22,222 in year 2000/01, £21,666 in year 2001/02 and £22,777 in the year 2002/03 which was paid to Mrs Patmore, the Appellant’s wife.  HMRC considered that this income was properly taxable on Mr Patmore as income arising under a settlement within the meaning of s660A Income and Corporation Taxes Act 1988 (“ICTA”).
Evidence 	
3.	Oral evidence at the hearing was given by Mr & Mrs Patmore and their accountant Mr McMorran who was the architect of the arrangements the subject of the appeal.
4.	The documentary evidence of what happened included:
•	The share sale agreement;
•	Company accounts and annual returns;
•	Minutes of “company” meetings
•	Dividend vouchers
•	A document headed “underlying philosophy”
The facts
5.	I find the facts to be as follows:
6.	Cambridge Dynamics Ltd (“ the Company”) was incorporated on 17 August 1978 and traded as an engineering business.  The founder, managing director and major shareholder of the company was a Mr M Henson.  Mr Patmore, the Appellant in this case, joined the company as an employee shortly after it was founded and later became a director.  In 2000 the Company had an issued share capital of 100 shares.  75 were owned by Mr Henson, 8 by his wife, and 1 each by his two children.  The remaining 15 were owned by Mr Patmore.
7.	 In 1998 Mr Henson indicated he wished to retire and sell his business.  After protracted negotiations, a share sale agreement was entered into on 14 January 2000.  The vendors were Mr & Mrs Henson and their two children.  The purchasers were Mr & Mrs Patmore.  The price was £320,000 (subject to adjustments dependant on subsequent profits).  £100,000 was paid on the day of completion.  £110,000 was due on 1 October 2000 and the final instalment of £110,000 was due on 1 October 2001.  I refer to these two stage payments as the Henson debt. These two deferred payments carried interest.  In the event, under the terms of the share purchase agreement,  there were some small adjustments downwards to the two stage payments due to diminished subsequent profits:  they were each in the event approximately £100,000.
8.	On completion Mr & Mrs Henson transferred their shares.  Mr Patmore took 83 shares giving him, together with his existing 15 shares, a 98% shareholding.  Mrs Patmore received 2 shares giving her a 2% shareholding.  Mr Patmore became the sole director and Mrs Patmore became company secretary. 
9.	The share sale agreement was between the four Hensons and Mr & Mrs Patmore.  We were not given a dated copy.  It was signed by both Mr & Mrs Patmore as “The Purchasers”.  It sold the 85 Henson shares to the Purchasers.  The Consideration was set out in clause 3 and was to be paid by the Purchasers.  Under the share sale agreement the obligations of the purchasers were joint and several.  Mr Patmore alone signed a separate deed in which he covenanted to pay the indebtedness under the share sale agreement and assigned a life policy as security.
10.	Mr and Mrs Patmore raised the initial £100,000 due and paid to the Hensons on 14 January 2000 by way of a mortgage securing a loan of £100,000 on their matrimonial home jointly owned by them.
11.	A company meeting was recorded as taking place on  31 March 2000.  At this meaning the existing 100 shares were re-named A shares.  100 new £1 shares without voting rights were created and called B shares.  10 were allotted to Mrs Patmore.  No other allotments took place.  
12.	At another company meeting on the same day the company paid a dividend of £1900 per B share.  No dividend was paid on the A shares.  The minute records that Mrs Patmore allowed the company to credit her dividend to Mr Patmore’s loan account.  Mr Patmore used the money to help repay the two stage payments to the Hensons under the share sale agreement.
13.	Later more dividends were paid on the B shares and on the A shares.  The B share dividends were always paid immediately by Mrs Patmore to Mr Patmore to use to pay off the Henson debt.  For the first four years the total of dividends paid was as follows:
Date	Total dividend on all A shares	Dividend paid on Mr P’s A shares	Dividend paid on Mrs P’s A shares	Total dividend on Mrs P’s 10 B shares	
6 April 2000				£19,000	
1 October 2000	£20,000	£19,600	£400	£20,000	
6 April 2001	£16,000	£15,680	£320	£10,000	
5 April 2002				£9,500	
6 April 2002	£105,000	£102,900	£2,100		
30 September 2002				£20,500	

14.	HMRC consider there to have been a further B dividend of £10,000 paid at some point in the tax year of 2002/3.  I do not find that it was.  One B dividend of £9,500 was paid on 5 April 2002 and a second of £20,500 on 30 September 2002.  These total £30,000 and as both were paid in the Company’s financial year which runs to 30 September 2002 they must be included in the total shown in the accounts for that financial year.  The accounts for that year shows the total B dividend as £40,000, which is it seems from where HMRC add in a further B dividend of £10,000.  However, it seems it was no more than a mistake in the accounts as the accounts for 2005 record that the B dividend in the year to end September 2003 was overstated by £10,000.  
15.	The accounts to end September 2003 show that there was an A dividend of £20,000.  It is not clear from the accounts what date this was paid but Mr McMorran’s evidence is that it was paid on 30 September 2003.  It is therefore irrelevant to the assessments under appeal the last tax year for which is 02/03.
Reasons for the structure
Appellant’s evidence
16.	Mr McMorran gave evidence about why the sale purchase and subsequent payment of dividends was structured in this way.  He said the Company was a manufacturing company operating in a high risk business.  It was vulnerable to bad debts and loss of business through re-location of major customers.  At the time of the share sale to the Patmores it had the additional risk of the uncertainty of not knowing how the business would maintain its market share after the loss on retirement of its creator and driving force Mr Hanson.  
17.	Mr McMorran negotiated the deal with the Hensons.  As stated above, the deal meant the Patmores had to find over £300,000 to buy the company.  £100,000 they raised from a mortgage on their home.  The two stage payments each just over £100,000 were funded (as they were intended to be) by dividends out of the company.  As Mr McMorran said, this was the only way the deal could have been done.  
18.	His explanation of why Mrs Patmore got only 2 of the original shares and was then later issued with B shares was that this was to protect Mrs Patmore from some of the risk but at the same time enable her to have a fair share of the dividends.  Mr McMorran saw Mrs Patmore as in effect buying her two shares from the Henson children.  In Mr McMorran’s view this meant she would not be exposed to the liability for the outstanding approximately £200,000 due to the Hensons in instalments for the other 83 shares.  
19.	At the same time he said he saw Mrs Patmore in reality being exposed to the Henson loans because if the stage payments were not made, Mr Patmore would become insolvent and the family’s financial position would implode.  
20.	He said that it was decided to have two classes of share, with some dividends paid solely on the B shares, to reflect the different levels of risk:  Mrs Patmore was the more at risk because she was exposed on the mortgage but had no control of the company and no day to day involvement with its running.  Mr Patmore was equally exposed on the mortgage but was in day to day control of the company.  Mr McMorran’s view was that this gave them the flexibility to pay dividends to Mrs Patmore without paying dividends to Mr Patmore.
21.	Mr McMorran likened Mrs Patmore’s position to that of an outside investor.  Outside investors would demand a separate class of shares with priority rights to dividends.  He said that he had provided HMRC with calculations from a company which specialised in advising on business purchases which showed that Mrs Patmore’s returns on the investment she had made of £150,000 (half of the £300,000 paid to buy the company) were in line with the returns an outside investor would have expected.  
22.	He says it was agreed in advance that Mrs Patmore would be initially prioritised on the dividends so that she could pay back the mortgage which was her chief exposure.  Mrs Patmore’ evidence, which we entirely accept, was that this was a major concern to her.
23.	Mr McMorran said that Mrs Patmore exercised free will when in the event (on his advice) she decided instead to pay the dividends to her husband to allow him to pay off the stage payments to the Hensons.  Mr McMorran gave this advice as the Company was doing less well than expected and if the dividends paid to Mrs Patmore had not been used to pay off part of the Henson loan, then more dividends would have had to be declared and the company would have become insolvent.  For this reason it was as much in Mrs Patmore’s interests as Mr Patmore’s interests for the loans to be repaid before the mortgage:  if the company had become insolvent Mr Patmore would have lost his source of income which was the only way of paying the interest on the bank mortgage.  Mr Patmore would have been bankrupt and the family home lost in any event.
24.	Mr McMorran’s evidence was that the entire strategy was pre-ordained other than the decision by Mrs P to pay the dividends to her husband rather than use them to repay the mortgage.  This was caused by the unanticipated falling profits in the company making it impossible to do as planned and repay the mortgage and the Henson debt.  The Henson debts had to be prioritised as the two stage payments had due dates.
HMRC’s view
25.	HMRC did not accept this evidence.   HMRC’s interpretation of the facts was that Mr Patmore owned the company and used his control of it to declare significant  dividends in favour of his wife so that they would attract a lower rate of tax.  However, Mrs Patmore never received the dividends as effectively they were always retained by Mr Patmore to repay the Henson debt.
26.	HMRC pointed out inconsistencies in Mr McMorran’s planning:
•	There was no need for class B shares to be created:  the Company could simply have issued more ordinary shares after the purchase took place to Mrs Patmore.  
•	The Class B shares carried no special rights to dividends.  
•	When the dividends were paid to Mrs Patmore, they were immediately paid by her to her husband to allow him to reduce the Henson loans. 
27.	HMRC also questioned the authenticity of some of the documents. The “underlying philosophy” was a document drawn up by Mr McMorran but signed by Mr Patmore.  It set out the reasons for the how the share purchase was structured, largely as I have reported in paragraphs 16-24 above.  There was no date by the signature at the foot, but it carried the date of 15 January 2000 at the top (the time of the share purchase that gave rise to the dividends the subject of this hearing).  It was drafted as if contemporaneous with the events it related in that it used the future tense such as “will be”.
28.	It was given to HMRC some years after the event.  Mr McMorran did not claim that it was a contemporaneous document and at the hearing said that it was merely a true reflection of what the Patmores’ intentions had been at the time of the share purchase.
29.	I find it was not contemporaneous.  I think that Mr McMorran and Mr Patmore should have made this clearer to HMRC when it was presented to them:  the fact that they did not does give this Tribunal pause to consider the reliability of what else they said.  In the event, as the facts of the financing of the deal and the actual payments of the dividends were not in dispute, little seems to turn on this.  It may well be that, contrary to the “Underlying philosophy” that at least part of Mr McMorran’s reasoning for the structure was that he considered it to be tax efficient:  this does not appear to be significant as s660A does not depend on motive.
30.	HMRC also put to Mr Patmore that he had signed the dividend vouchers “recently”.  Mr Patmore denied this, and we accept this evidence.  The dividends were reported relatively contemporaneously in the company accounts and then in the Patmore’s tax returns: they were paid and HMRC does not dispute this.  It seems improbable that the vouchers were not contemporaneous with the payments and nothing turns on it if they were not.  HMRC also questioned the date of the allotment as the minutes record it as being 31 March 2001.  However, the evidence from Mr McMorran was that this was merely a typographical error and the date should have read 31 March 2000.  The accounts for year ended September 2000 show 10 B shares as having been allotted.  Therefore, the Tribunal accepts the evidence of the Appellant that this was merely a typographical error.  HMRC did not in fact dispute that the shares had been allotted: indeed their assessment to tax depended on the allotment having taken place.
This Tribunal’s view
31.	Mr McMorran was the main witness for the Appellants.  Although both Mr & Mrs Patmore gave evidence, neither of them recollected clearly what had happened 10 years before.  It was also their evidence, which the Tribunal accepts, that they had relied heavily on Mr McMorran to advise them on the entire structure and that they did not fully understand the position.  Mrs Patmore had no involvement with the company before she purchased it with her husband.  Her evidence was that she was concerned about what would happen if someone else took over the company which employed her husband but at the same time very concerned about the risks of buying the company.  
32.	There were inconsistencies in Mr McMorran’s strategy.  Although he accepted that in practice Mrs Patmore did have equal exposure with her husband on the share purchase agreement, he thought that in law she did not.  This was a mistake.   Mrs Patmore signed the share purchase agreement and there was no clause limiting her liability: she had equal liability.  Mr McMorran may have been misled because Mr Patmore was the only signatory to the Deed of Covenant. 
33.	Mr McMorran also insisted that the arrangement put Mrs Patmore in an equivalent position as an outside investor.  This is clearly wrong.  An outside investor would have wanted some guarantees:  Mrs Patmore got none.  Mr McMorran did not seem to see the difference between Mrs Patmore getting priority dividends on her B shares (which she did) and being entitled to get priority dividends on her B shares (which she was not).  The B shares carried no rights to a dividend and there was no agreement to pay a particular amount or % of a dividend.  There was an understanding that Mrs Patmore would be paid a B dividend:  but we find it was to pay when and whatever Mr McMorran advised as reasonable.  This was so vague as to be unenforceable. The Patmores acted as rational married persons who trusted each other in arranging their affairs:   but the arrangements made by Mrs Patmore would not have been acceptable to an outside investor.  
34.	Further, although we do find that it was originally the intention that the dividend  paid to Mrs Patmore would be used to repay the mortgage, in the  event the Patmores could not afford to do this (the mortgage could wait but the Henson loans would fall due and had to be paid).  I find that the Company (controlled by Mr Patmore) would not have paid the dividends if Mrs Patmore had not already agreed to pay them back to her husband.  I find this because the minutes themselves show that events were back to back and so it is inconceivable there were no discussions between the parties (bearing in mind they were married) before hand and in any event Mr and Mrs Patmore were responsible people and Mrs Patmore was not going to take action detrimental to the Company’s long term financial health and ultimately the finances of her own family.
35.	We find that the agreement was that Mrs Patmore, in return for her equal investment with her husband, would get far fewer shares than him and have no control over the company but that she would get a much more equal share of the dividends.  Nevertheless these dividends would be at the discretion of Mr Patmore, and in the event I find that they were only paid to Mrs Patmore on the understanding she would pay them to Mr Patmore.
The law
36.	HMRC considers that most of the dividends paid to Mrs Patmore on her B shares should be taxed on Mr Patmore because s660 Income & Corporation Taxes Act (“ICTA”) 1988 applies.  S660 taxes on the settler any income arising under a settlement in which the settler retains an interest.  It provides in so far as relevant as follows:
660A Income arising under settlement where settlor retains an interest
(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.
(2) Subject to the following provisions of this section, 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.
(3) The reference in subsection (2) above to the spouse of the settlor does not include—
(a) a person to whom the settlor is not for the time being married but may later marry, or
 (b) a spouse from whom the settlor is separated under an order of a court, or under a separation agreement or in such circumstances that the separation is likely to be permanent, or
 (c) the widow or widower of the settlor.
(4) A settlor shall not be regarded as having an interest in property by virtue of subsection (2) above if and so long as none of that property, and no derived property, can become payable or applicable as mentioned in that subsection except in the event of—
 (a) the bankruptcy of some person who is or may become beneficially entitled to the property or any derived property, or
 (b) an assignment of or charge on the property or any derived property being made or given by some such person, or
  (c) in the case of a marriage settlement, the death of both parties to the marriage and of all or any of the children of the marriage, or
 (d) the death of a child of the settlor who had become beneficially entitled to the property or any derived property at an age not exceeding 25.
(5) A settlor shall not be regarded as having an interest in property by virtue of subsection (2) above if and so long as some person is alive and under the age of 25 during whose life that property, or any derived property, cannot become payable or applicable as mentioned in that subsection except in the event of that person becoming bankrupt or assigning or charging his interest in the property or any derived property.
(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.
(7)…..
(8) Subsection (1) above does not apply to income arising under a settlement made by one party to a marriage by way of provision for the other—
(a) after the dissolution or annulment of the marriage, or
 (b) while they are separated under an order of a court, or under a separation agreement or in such circumstances that the separation is likely to be permanent,
being income payable to or applicable for the benefit of that other party.
(9) Subsection (1) above does not apply to income consisting of—
(a) annual payments made by an individual for bona fide commercial reasons in connection with his trade, profession or vocation; or
(b) qualifying donations for the purposes of section 25 of the Finance Act 1990; or
 (c) a benefit under an approved pension arrangement
(10) ….
(11) …..
(12) …..”

37.	The main dispute between the parties was whether the dividends were income arising under a settlement within s660A(1).  It was accepted that the exemption at the end of s660A(1) for “property in which the settlor has no interest” did not apply as s660A(2) deemed a settlor to have an interest in anything in which his spouse had an interest.
38.	HMRC had raised two routes by which a settlement might have arisen on the facts of this case.  Firstly, they considered the B shares themselves were the subject matter of the settlement, although they considered this the weaker argument.  Mr McMorran disputed this both because he did not think that the shares were ‘settled’ on Mrs Patmore and also because he was of the opinion that HMRC had given up the right to argue this in their letter to him of 28 April 2004.  I cannot agree that HMRC gave up the right to argue this point.  They say in their letter “on a strictly without prejudice basis” they would be prepared to give up arguing that the B shares were settled in the context of asking Mr McMorran to agree that the payment of the dividends were bounteous.  He did not accept this offer so HMRC are not bound by it.
39.	Therefore I did consider whether the B shares were settled on Mrs Patmore.  In the case of Jones v Garnett  [2007] UKHL 35 a husband and wife each acquired one share in an off the shelf company.  The husband then operated this company, Arctic Systems, as his personal service company.  The wife contributed nothing to the company apart from her services as company secretary for which she was separately rewarded.  The husband chose to take a low salary and pay out a significant amount of what was in effect his earnings as dividends, half of which were paid to his wife as owner of 50% of the shares.  This arrangement was contemplated from the outset.  The House of Lords found that there was a settlement on the wife (although it was not caught by s660A because of the exemption for outright gifts, to which I refer below).
40.	 This case shows that shares, of little or no value when settled (such as the B shares in this case as they carried no rights to dividends, or the £1 share in Arctic Systems at the time it was transferred to the wife) can nevertheless be the subject of a settlement and that once settled, all dividends paid under them during  the life of the settlor subject to tax on the settlor.  
41.	Mr McMorran sought to distinguish the Patmore’s case from Arctic Systems by pointing out that the Company was far removed from a personal service company: it was a substantial enterprise with 18 employees and a factory.  The Tribunal does not see that this is a distinction with any relevance.  
42.	The second route to settlement put forward by HMRC was that each time the company, controlled as it was by Mr Patmore, chose to issue a dividend on the B shares without a pari passu dividend on the A shares, Mr Patmore was effectively creating a settlement in favour of his wife by waiving his right to a dividend on the A shares.  The B shares had no special rights to dividends and it was accepted by both parties that they ranked equally with the A shares on dividend rights. 
43.	HMRC recognised that if the Tribunal accepted this logic then it must mean that 12/110 of the dividend ought to belong to Mrs Patmore in any event as owner of 2 A shares and 10 B shares out of a total issued share capital of 110 shares.  At the hearing they proposed, therefore, that the assessments should be upheld in principle but reduced to 98/110 of the original amount.  
Were the B shares settled on Mrs Patmore?
44.	S660G contains the relevant definitions:
“(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.
(2)	A person shall be deemed for the purposes 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, or has made with any other person a reciprocal arrangement for that other person to make or enter into the settlement.”
45.	A settlement includes an arrangement. Arctic Systems indicates a broad interpretation:  relatively valueless shares which are given to a spouse in circumstances where it is intended future dividends will be paid on them can amount to an arrangement.  This would cover the facts of this case.  Trust deeds are not necessary.  Mr Baldry for HMRC referred me to the decision of the Special Commissioner (Sir Stephen Oliver QC) in Bird (2008) Spc720 and in particular to paragraph 21 where he said:
“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; IRC v Gunner (1940) 23 TC 610 to Butler (Inspector of Taxes) v Wilden.  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 [2007] STC 1536 at [48] – [49], 78 TC 597 at [48]-[49] per Lord Walker of Gestingthorpe).  In this connection it will be noted that Lord Hoffman expressly approved the ‘realistic view’ that the court should take of the matter.”
46.	I agree.  There was an arrangement here.  There was no legal trust nor even a written contract but there was an understanding between the parties that Mrs Patmore would be given B shares and dividends would be paid on them.
The gift element
47.	But it is not enough for s660A to apply for there to be an arrangement. It is implicit in s660A that the arrangement must contain an element of gift:  it uses the words “settlement” and “settlor” and without such a restriction every commercial contract would be caught.  The case law is also quite clear that there must be gratuity in the arrangement although Lord Hoffman in Arctic Systems said that the usual phrase of “element of bounty” might not be the happiest way to describe it.  He said in Jones v Garnett  [2007] UKHL 35 at paragraph 7:
“Not every transfer of property is a settlement for the purposes of section 660A.  There has to be an “element of bounty” in the transaction.  This is an old-fashioned phrase, apparently derived from the judgment of Plowman J in Commissioners of Inland Revenue v Leiner (1964) 41 TC 589, 596 and approved by the House of Lords in Inland Revenue Commissioners v Plummer [1980] AC 896,913, conjuring up the image of Lady Bountiful in The Beaux’ Stratagem, is perhaps not the happiest way of describing a provision for a spouse or minor children.  A donation to a spouse or child is traditionally expressed in a deed to be ‘in consideration of natural love and affection’ rather than the donor’s bounty.  It is nevertheless exactly the kind of thing at which the anti-avoidance provisions are aimed.  In Chinn v Hochstrasser [1981] AC 533, 555 Lord Roskill cautioned against treating the word “bounty” as if it had been included in the statute.  It seems to me that the general effect of the cases is that, under the arrangement, the settlor must provide a benefit which would not have been provided in a transaction at arm’s length.”

48.	Mr McMorran considered that there was no element of bounty in the Patmore’s arrangements.  He says that Mr Patmore could have done this deal with stranger.  As I have already said, I do not accept this.  While in the event Mrs Patmore might actually have received acceptable returns, she had no guarantees of any returns nor any right to a priority dividend.  I find that unlike Mrs Patmore, no third party would have been prepared to contribute 50% of the purchase price in return for 2% of the voting shares and 10 non-voting shares with no priority rights to dividends.
49.	Mr McMorran referred to the decision of Nourse J in Levy [1982] STC 442 where the finding was that the settlement included no element of bounty because the “settlor” loaned money to the company:  a loan includes no element of bounty because it is not a gift but repayable.  While this is both binding on me and clearly right it is not obviously relevant in this case where there was no loan by Mrs Patmore.  I do agree, as said above, that unless there is an element of gift, there is no settlement under s660A and I will return to this point below.
50.	Mr McMorran also mentioned the s660A(9)(1)(a) exception for bona fide commercial payments.  This clearly is inapplicable.  As I have found, the payments were not of the sort that parties at arms-length would have entered into.  
51.	Mr McMorran also cited HMRC’s published policy  in HMRC Tax Bulletin  for April 2003 at page 1015 (which appears to be the same as IR 64 at page 519/520) where they say:
“ A purely commercial transaction or series of transactions at arms length is outside the meaning of ‘settlement’.  Most commonly the legislation will apply where individuals seek to divert income to members of their family or to friends.  A good test of whether or not the legislation could apply is to consider would the same payments be made to a person who acquired shares in a company or a share of a partnership at arms length.  Or whether income is being paid simply because the recipient is your spouse or child or some other individual you might wish to benefit.”
52.	HMRC’s written policy is of course not binding on this Tribunal:  it is not the law, merely HMRC’s understanding of it.   But in any event, it does not help Mr McMorran:  this was not a purely commercial transaction.
53.	HMRC considered that the arrangement between Mr and Mrs Patmore was clearly not one that would have been arrived out in a commercial, arm’s length deal and therefore it was a “settlement”.
54.	I cannot agree with HMRC either.  The House of Lords in Arctic Systems was looking for an element of gratuity: a benefit provided by the settlor which would not have been provided in an arm’s length transaction.  I struggle to see any element of bounty by Mr Patmore.  Mrs Patmore was jointly liable with Mr Patmore on the mortgage and Henson debt.  She contributed equally to him in the purchase of the 85 shares.  In return, she was given a mere 2 shares and was later allotted 10 B shares with no rights to a dividend.
55.	HMRC say in their letter of 13 September 2006 in reply to one of Mr McMorran’s:  “…you refer to Mrs Patmore’s ‘risk and participation in respect of the business’, but Mr Patmore had a similar (or, as director of the company, a greater) risk.  However, although Mrs Patmore held only 11% of the share capital of the company (and the B shares have less rights attached to them than the A shares have), she received 40% of the dividends.  This cannot be considered equitable”.  This letter clearly overlooked the fact that Mrs Patmore was an equal buyer of the company with Mr Patmore, a fact HMRC had recognised in their earlier letter of 28 April 2004 (quoted in paragraph 61 below).  The inequity was not in Mrs Patmore receiving 40% of the dividends but in that she did not receive 40% of the shares.
56.	As I raised with Mr Baldry at the hearing, it seemed to me that the facts of this case would give rise to a constructive trust over some of the A shares in favour of Mrs Patmore.  Counsel had not previously considered this but was prepared to concede it was possible but seemed to doubt its relevance.  
57.	The constructive trust point was not raised by the Appellant:  they did not comment on it and without legal representation were not in a position to comment on it.  This Tribunal is not restricted to considering only those points raised by the parties especially when they are without legal representation.  I take into account that the reason given for Mrs Patmore getting less than her fair share of the shares in the Company was not that she intended a gift but that it was to protect her from liability.
58.	I find there was a constructive trust in Mrs Patmore’s favour.  She contributed half of the capital to buy the shares by being jointly liable with her husband on the Henson loan and on the mortgage of the jointly owned house.  It was clear to me from the Patmores’ evidence that the purchase of the company was a joint enterprise by Mr and Mrs Patmore to secure their financial future.  Mrs Patmore did not intend to “give” her half share to her husband.  They just took Mr McMorran’s advice, which they did not fully understand, which was to allot to her B shares rather than transfer to her half of the 85 A shares which they had jointly purchased.    The B shares were not a fair recognition of her investment as they were almost valueless, carrying no rights to vote nor rights to a dividend (any dividend paid was paid entirely at Mr Patmore’s discretion).
59.	It seems to me therefore that a constructive trust in Mrs Patmore’s favour over 40.5 A shares arose when they were purchased.  This is because Mrs Patmore was entitled to half of 85 A shares (ie 42.5 shares) but in fact received only 2 A shares and a promise of almost valueless B shares.  These 40.5 shares were held in law by Mr Patmore but on trust for Mrs Patmore.
60.	Therefore, when Mr Patmore did cause the company to allot the 10 B shares to Mrs Patmore it seems to me that although the arrangement was not commercial it was not gratuitous either.  It was a recognition, albeit a very inadequate one, of her rights to  shares in the company.  There was no bounty.  He “owed” her more than 10 B shares.  If he had transferred to her 40 of his A shares it would not have been gratuitous as she was entitled to them:  the allotment instead of the (almost valueless) B shares cannot therefore be gratuitous.
61.	Lord Hoffman in  Arctic Systems at paragraph 11 said that the courts should take “a broad and realistic view” of the arrangements.  It certainly seems to me that this is a case where HMRC has not done so.  They recognised in their letter of 28 April 2004 that “..it is accepted that Mrs Patmore has a joint and equal responsibility for the loans used to acquire the original share capital of the company” yet they have not recognised that this would entitle her to half of the acquired share capital and an appropriate share of the dividends.
62.	In most of the other cases cited to me there was no suggestion that the settlor received something of value in return for the “settlement”.  They are therefore not comparable to this case.  For instance, in Buck [2009] STC 6 a company director owned 9999 shares and his spouse the other 1 share in a company.  He waived his rights to a dividend and the entire dividend was therefore paid to his wife as owner of 1 share.  There was no suggestion that she had done anything to be entitled to this large dividend:  the question for the Tribunal was whether there was an arrangement within the meaning of s660A.  The element of bounty was clearly present.
63.	However, in Bird [2009] STC 81 loans were made to the company from an estate the ultimate beneficiaries of which would be the two shareholders’ minor children.  Once the loans were made, the shareholders caused the company to allot shares to their minor children and pay dividends on them.  They claimed that the allotment and dividends were in consideration of the loans and not gratuitous.  The Tribunal found as a fact that this was not so.  The loans carried interest and were repayable (and repaid).  The issue of shares was not in consideration of the loans.  The arrangement to allot the shares was therefore caught by s660A as gratuitous.  This is quite different to this case where I have found as a fact that when Mr Patmore caused the issue of the B shares by the Company to Mrs Patmore this was not gratuitous.  
Exemption for outright gifts
64.	Having decided that the B shares were not settled on Mrs Patmore within the meaning of s660A, I do not need to consider whether the exception for outright gifts between spouses in s660A(6) applies.  Nevertheless, it was argued, so I will record my views.
65.	S660A allows outright gifts from one spouse to another to be ignored in certain instances.  The requirements are that it must be an outright gift of property from which income arises.  Ordinary shares are property from which income arises: there can be an outright gift of them within the meaning of s660A as found by the House of Lords in  Jones v Garnett.  On the other hand, preference shares have been found to be “wholly or substantially a right to income” and so they are excepted from the exemption (see Young v Pearce [1996] STC 743).  So in this case, the B shares as ordinary shares, could be within s660A(6) if there was an outright gift of them.
66.	S660A(6) last sub-paragraph provides that:
“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.”
67.	It appeared to form no part of HMRC’s case that s660A(6) did not apply because the income from it (the dividends on the B shares) were paid for the benefit of the donor (Mr Patmore).  Yet, they were paid for his benefit as no sooner were the dividends declared, Mrs Patmore gave them to her husband.  
68.	It seems unlikely in the extreme that the interpretation of the last sentence of s660A(6) is that it captures all outright gifts as there is always a power for the donee to give the property back to the donor. If this were the correct interpretation it would render s660A(6) entirely otiose.   It seems to me that the proper interpretation of this qualification on “outright gift” is that it applies where the pre-existing arrangement is that the income will or is or might be applied for the donor’s benefit.
69.	I have found (see paragraph 33) that it was no part of the original arrangement that Mrs Patmore would pay the dividends back to her husband:  this only became part of the arrangement at the time the dividends were actually paid.  However, it was always intended that Mrs Patmore would use the dividends to pay off the mortgage.  It was clearly no part of the arrangement that Mrs Patmore use the money for a purpose other than that of repaying the loans to buy the company.   All three witnesses understood the necessity to the Patmores of using the dividends to repay the loans taken out to buy the company.  As Mr Patmore was both liable on the Henson loans and on the bank loan secured by the mortgage it follows that the exception to s660A(6) must apply.  In all (and not just any) circumstances it was part of the arrangement that the dividends were going to be applied at least in part to Mr Patmore’s benefit as he was as much liable on the debts as his wife.  Therefore, unlike Arctic Systems, I would find that there was no outright gift of the B shares (except of course that I have found that the B shares were not settled at all).
Were the B dividends settled on Mrs Patmore?
70.	Having decided that the B shares were not settled on Mrs Patmore, I move on to consider HMRC’s main case that the B dividends were settled on Mrs Patmore.
71.	Mr McMorran’s case was that that structure adopted with the B shares and B dividends paid to Mrs Patmore was entirely commercial and without an element of bounty.  As I have already said,  I do not agree with the reasons he advances for this:  the arrangement was not one which made sense outside of marriage and not one a third party would have agreed to enter upon.  Mr McMorran did not consider the payment of the B dividends could be a settlement and distinguished the Buck case as one of mere income shifting and distinct from this case.
72.	I do not agree.  I accept HMRC’s arguments that a decision by the controlling shareholder to only issue a dividend on one class of shares rather than another (B shares in this case in preference to A shares) can be an arrangement caught by s660A.  This follows generally from expansive wording of section 660G(1) to include “arrangement” and the need to take a “broad and realistic view” of the arrangements as per Lord Hoffman in Jones v Garnett.  A finding that to chose to pay a dividend on only one kind of share can be a settlement is consistent with the Tribunal’s findings in Buck, where the shareholder waived his own dividends in favour of his wife (where there was only one class of shares).
73.	However, as with the allotment of the shares themselves,  S660A only applies where the arrangement involves gratuity. The arrangement in this case was not a commercial arrangement: but the lack of commerciality was on both sides.  I have already found that Mr Patmore held 40.5% of the A shares in the Company in trust for Mrs Patmore.  In causing her to be paid dividends (albeit on the B shares) he was paying her dividends to which she was at least in part entitled.  And to the extent she was entitled to the dividends there was no gratuity and therefore no settlement within s660A.
74.	If and to the extent that the dividends she was paid exceeded her entitlement as the beneficial owner of 42.5 of the A shares, I find that there was a settlement within s660A.  
75.	Therefore I went on to consider whether the B dividends would be excepted from s660A on the grounds they were outright gifts.  The answer is no.  The answer is no because s660A(6)(b) (see paragraph 35) provides that the exception does not apply where the “property given is wholly or substantially a right to income.”  Dividends are income.  It may at first glance seem illogical that statute allows an exemption for giving away capital from which income is derived (such as a gift of shares) but not the lesser gift of just the income.  Although not necessary for my decision, I assume that this is because Parliament wished to allow a person to entirely divest themselves of property in favour of their spouse so that for all purposes separate taxation would then apply.  What Parliament did not want is for a spouse to decide year on year that his or her income could be given to the spouse in order to get a lower rate of tax.
76.	I note that the Special Commissioner in Buck v Revenue and Customs Commissioners [2009] STC 6 came to the same conclusion at para 21 in respect of a dividend waiver.  There is no outright gift within s660A(6) where income is concerned.
77.	In any event even if it were not for the exception against gifts of income in s660(6), the settlement (to the extent there was one) could not, any more than the alleged gift of the B shares themselves, be an outright gift because the last exception in that sub-section applies (set out in full in paragraph 66  above).  The arrangement was that the dividend income would be used by Mrs Patmore to discharge the mortgage on which both Mr and Mrs Patmore were liable and not for any other purpose:  the property given would therefore become applicable for the benefit of the donor.
My decision
78.	For the tax year to April 2000 no A dividends were paid.  B dividends of £19,000 were paid.  Mrs Patmore was entitled to 42.5% of this dividend.  The tax assessment for the year to April 2000 should therefore be reduced to reflect this. I leave it to the parties to agree the tax calculation.
79.	For the tax year to April 2001, £20,000 dividends were paid on A shares and £20,000 dividends paid on B shares.  Mrs Patmore was entitled to 42.5% of the entire dividend of £40,000.  The tax assessment for the year to April 2001 should therefore be reduced to reflect this.  I will leave it to the parties to agree the tax calculation.
80.	For the tax year to 5 April 2002, £16,000 in dividends was paid on the A shares and £19,500 paid on the B shares.  Mrs Patmore was entitled to 42.5% of the entire dividend of £35,500.  The tax assessment for the year to April 2001 should therefore be reduced to reflect this.  I will leave it to the parties to agree the tax calculation.
81.	For the tax year to April 2003, £105,000 was paid in A dividends and £20,500 in B dividends. Mrs Patmore was entitled to 42.5% of the entire dividend paid, some £53,337, but actually only received £22,600.   So it seems that not only should the tax assessment for this year be reduced to nil, but Mr Patmore has overpaid tax because a considerable part of the A dividend paid to him should have been taxed on his wife.  I was not addressed on the issue of whether Mr Patmore is in time to alter his self assessment return to reflect my findings.
82.	My view is that over the four years Mrs Patmore received 41.73% which was slightly less than the 42.5% of the dividend to which she was entitled, and that HMRC should consider equitable liability before enforcing tax assessments in the earlier years ( 99/00, 00/01 & 01/02) without giving Mr Patmore credit for the later year (02/03) where he over paid tax.  
83.	This concludes my decision.  For completeness, however, I mention one last point.
Did Mrs Patmore make a settlement on Mr Patmore?
84.	  This issue did not occur to me at the hearing and therefore I did not have the benefit of Mr McMorran’s or Mr Baldry’s view on it.  However, I see no point at this stage in asking for their submissions on it as it is not the principle on which I am deciding the case.  However, it does seem a valid point to mention in case an appeal is contemplated.
85.	 The point is that it seems to me that there are only two possible interpretations of why Mrs Patmore, equally liable with her husband to pay the consideration on the purchase of the company, received considerably less than her fair division of the shares.  Either she intended to give up her entitlement in favour of her husband or she did not.  I have found as a matter of fact that she did not intend a gift.  This led me to conclude that Mr Patmore held some of the shares on constructive trust for her and that her receipt of the B shares and dividends up to 42.5% of the dividend paid did not therefore involve an element of bounty on his part.  The effect was that (at least to some extent) the tax assessments on Mr Patmore cannot stand.
86.	The same answer it seems to me would follow, however, if I had found that Mrs Patmore had intended a gift to her husband.  And this is because of the operation of s660A.  For all the reasons given above, a settlement for the purposes of s660A can arise under the most informal of arrangements, such as the arrangement in this case.  The real question is whether there is an element of gratuity.  If Mrs Patmore had intended to give up her entitlement to shares in the company in favour of her husband and take no recompense, such that the issue of the B shares and the later dividends paid to her by the company, but at Mr Patmore’s direction, really were gratuitous, then Mrs Patmore herself would have created a settlement on her husband.  She would have settled half of the 85 shares purchased on him.
87.	Would the exemption for outright gifts in s660A(6) have applied?  For the reasons given above, I would conclude that it would not.  It was always intended dividends would be paid to her.  Further,  Mrs Patmore was liable on the mortgage and Henson loan.  It was always intended that these would be repaid out of dividends.  So clearly the property or income derived from it might become payable for her benefit.  There was no “outright gift”.
88.	It is perhaps easier to see this if one suspends for the moment the knowledge that Mrs Patmore paid tax at a lower rate than her husband.  Had it been the other way round, the applicability of s660A (in the circumstances that Mrs Patmore intended a gift – contrary to my findings in this case) is much more apparent.  So under this scenario 50% of 85% of the dividends would have been taxable on Mrs Patmore as settlor. So much the same result would have ensued for tax purposes.
89.	This document contains full findings of fact and reasons for the decision. Any party dissatisfied with this decision has a right to apply for permission to appeal against it pursuant to Rule 39 of the Tribunal Procedure (First-tier Tribunal) (Tax Chamber) Rules 2009.   The application must be received by this Tribunal not later than 56 days after this decision is sent to that party.  The parties are referred to “Guidance to accompany a Decision from the First-tier Tribunal (Tax Chamber)” which accompanies and forms part of this decision notice.

TRIBUNAL JUDGE
RELEASE DATE: 14 July 2010