An upset for HMRC: a new settlements case features a husband and wife, different share classes and dividends, but who was the settlor?

  • The Settlement provisions are a set of tax anti-avoidance rules designed to stop individuals from avoiding tax by artificially diverting their income to other family members.
  • So, if an individual tries to reduce his own tax bill by routing his income to another person, whilst still retaining an interest in either the income or the underlying asset that created the income (such as a share), the settlement rules will apply to tax him on the income (as if he had never given it away).

In 2000 Mr and Mrs Patmore (Mr and Mrs P) purchased the shares of an engineering company by way of loans. Their accountant then created new shares with the result that the husband held 98% of the A ordinary voting shares and the wife 2%. The wife was then given 10 B non-voting shares.

The accountant also recommended that larger dividends were paid on the B shares. Mrs P then transferred this cash to Mr P’s loan account where it was used to repay the loan.

The accountant presumably set this up in this way to try and utilise the wife’s lower tax band.

Dividends were paid as follows:


A shares

Mr P’s A shares

Mrs P’s A shares

Dividend on Mrs P’s 10 B shares

6 April 2000





1 October 2000





6 April 2001





5 April 2002





6 April 2002





30 September 2002





HMRC raised assessments on the husband for the years 1999/00 to 01/02 for half of the wife’s dividends on the basis that section 660 ICTA 1988 applied: the husband was the settlor and he had created a settlement in giving his wife non-voting shares so that she could then benefit from his income earned via the company and paid out as dividends.

The Tax Tribunal did not agree with this analysis, because unlike the 1996 cases of Young v Pearce and Young v Scrutton, in which wives were given non-voting shares by their husbands, and it was determined that a settlement therefore applied, Mrs P had contributed 50% of the capital to purchase the shares, and in return had only received 2% of the voting shares and 10 non-voting shares.

A contructive trust?
HMRC’s arguments took a turn for the worse when the Tribunal Judge Barabara Mosedale took the unfair allocation of A ordinary shares between the couple to indicate that there was a constructive trust in Mrs P’s favour. Mrs P purchased half of the A ordinary shares but only received 2%. She was given 10 non-voting shares but the judge did not agree that this was fair by way of compensation and so did not amount to a settlement.

What of the dividends on the 10 non voting shares?
The judge decided that half of this income was the husbands. The effect was similar as if both parties had ordinary shares but he had waived his right to a dividend and therefore the settlement provisions bit, at least in part, because the right to a dividend is a only right to income and so the spousal exemption for outright gifts does not apply. This follows judgment in the recent case of Buck v HMRC, and of course Young v Pearce etc.

There are two twists in the tale of this case. The judge decided that if the constructive trust argument was not followed then the wife was capable of being a settlor too.

The judge decided to reallocate the dividend income declared on all classes of shares between the spouses. It meant that in the later year of 2002/03 that it was the husband’s not the wife’s assessment which should be decreased. Taking the adjustments for 1999/00 to 2002/03 in total, £16,000 of additional income should be assessed on the wife, decreasing her husband’s assessments by the same amount. HMRC had assessed an additional £40,000 on the husband and so the result is - £56,000.

Whether HMRC will agree to offsetting 2002/03 is another matter, that year has fallen out of assessment. The judge suggested that it should consider equitable liability.

Editorial comment
An interesting, if slightly unusual case, with unsurprising results because marriage, combined with business and the settlement rules simply do not mix in practical tax terms.

Mr and Mrs P do not seem to have been well advised (why do people continue to put these daft share structures in place? – Young v Pearce etc are cases which date back to the mid-ninties).

If you read the judgment you will also note that their accountant, did not help. He seems to have backdated documents and not being legally versed meant that he missed a trick of two. He was lucky to have such a helpful judge take up the slack for him, but I wonder if the case would have gone to court if the couple had well, slightly more competent representation from the start?

The result troubles me, surely if you were to take a broad brush approach in this case as Judge Mosedale says she did here (following the decision in Arctic Systems,) you would see the couple as one unit, sharing risks and rewards and leave it as that. Was reapportioning income on the basis of constructive trust a step too far? We will have to wait and see if HMRC wants to appeal. On a cost v benefit basis it does not look worthwhile or in the public's interest, besides, if it just digs in and refuses to give relief under equitable liability it will net all of £6k.

Source: Tax Tribunal website, decision number TC 00619 David Thomas Patmore v HMRC