This landmark case may finally have established that the Inland Revenue must allow some husband and wife limited companies to operate as if they are a genuine business partnership, allowing spouses to share income and resulting tax allowances. But contractors should still be very cautious if embarking on this route.
IR35 Case 3 - Husband and Wife companies
Key lessons from this case
- The Inland Revenue tried to prove that a wife′s shares in the husband and wife business were a ‘settlement′ from the husband, meaning any income should be treated and taxed as the husband′s
- Certain conditions and actions convinced the court that the share allocation was not a settlement and the wife′s dividends were legitimately hers
- A precedent has been established in case law that husband and wife companies can share income and tax allowances, under certain conditions and assuming certain actions have been taken
- This case overturns the judgment in IR35 Case 6, although the principles of the Case 6 judgement could apply in some cases.
Summary of the case
Background
This is the possible completion of a string of cases relating to a classic approach by the Inland Revenue for establishing whether IR35 conditions apply. Geoffrey Jones and his wife created Arctic Systems Ltd in order to secure IT consulting contracts through agencies that would only deal with limited companies.
Why did the Inland Revenue act?
The IR originally took action because they wanted to demonstrate the allocation of shares to Mrs Jones was an act of settlement by Mr Jones in order to reduce tax and National Insurance liabilities. The IR took action under IR35 and tried to prove Mrs Jones′ earnings should be treated as Mr Jones′ earnings because of the settlement issue.
Why did the contractors appeal?
In this case Mr Jones and Arctic Systems appealed on the basis that:
- The allocation of shares was not a settlement, as there was no element of bounty at the time of the share transfer
- The transfer had the status of being an outright gift between spouses and therefore exempted from being a settlement
- The casting vote used by the chair of the previous judgement was not properly used
Who won and why?
Arctic Systems won the two key elements of the case because the judge was not satisfied that the previous hearing before the Special Commissioners (see Case 6) correctly interpreted the law in this case and had not applied certain facts.
- The facts and paper trail showed Mrs Jones actually bought the shares directly from the original third party subscriber via her accountants with her own money, meaning Mr Jones did not settle them on her
- In addition, at the time the shares were allocated, there was no actual prospect of income or "bounty" from the settlement, which is a condition of an arrangement like this being a settlement
- There were no formal board meetings and no contracts of employment, therefore in theory Mr Jones had no obligation to generate fees and at the time of allocation (and subsequently) Mrs Jones′ share would not attract income (bounty), so again the allocation of shares was not a settlement
- Although Mr Jones was the only director and therefore decided to issues dividends, he was on record as saying he would be happy if she was appointed
- Mr Jones lost the third element of the case, that the casting vote was incorrectly used, as the judge felt the issue irrelevant with little chance of success.
It is important to note that in some husband and wife and family businesses, where the situation was only slightly different, the circumstances may have qualified as a settlement.
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