S660 Background
The s660 rules (or settlements legislation) have been around since the 1930s.
The original rules stop you passing income to someone else in the family, or giving income or assets to someone else in an effort to reduce your overall tax bill. This is called a "settlement", and the aim of the legislation is to stop people settling their income on another person who pays tax at a lower rate.
In such companies a husband and wife may, for example, each own an equal number of shares with one of them the main fee-earner and the other responsible for relatively little or no fee income. By paying out the profits by way of dividend, income earned by one of the couple can be partly received and taxed on the other resulting in an overall saving on tax since there will be two lots of personal allowance and basic rate tax band to use up. This is currently a very common scenario with thousands of husband and wife companies using what had always been deemed acceptable tax planning.
The last four years has seen uncertainty and confusion surrounding the taxation of family businesses with the case of Arctic Systems Ltd (Geoff and Diana Jones). The Revenue's argument was that if the wife's income stems mostly from the husband's work, then he has given her a right to his income i.e. the dividends that she gets on her shares in the Company, and therefore this should fall under S660 as a settlement.
Controversially, Arctic Systems initially lost their case even though the decision was not unanimous, resulting in a growing body of experts voicing a need for the decision to be challenged in a bid for clarity. Clouding the waters further, the Revenue said individual cases of settlement law would be decided on a case-by-case basis by considering the "whole arrangement." In the same year, the Revenue issued a 49-page advice document enforcing the taxman's controversial settlement legislation to "prevent an individual from gaining a tax advantage," through the transfer of assets. The document says the low-income partner should be taxed at his or her partner's rate of tax, which is more likely to be in the higher band tax rating.
Subsequently the Joneses lost their High Court appeal in March 2005, with courts effectively dismissing a wife's contribution to such family businesses and ruling that such families cannot share both the rewards as well as the risks of that business. With the judgement highlighting Geoff Jones' salary, experts' advice was that if contractors wanted to keep "off the Revenue's radar screen, paying a market rate salary would be sensible".
The third decision in the long running saga saw the Court of Appeal find in favour of the Joneses in December 2005, but HM Revenue & Customs decided to fight the unanimous ruling that Arctic Systems did not owe a retrospective tax bill a month later in January 2006. However, in July 2007, the House of Lords roundly rejected the appeal by HMRC. The PCG estimated that British taxpayers faced a bill of over half a million pounds for the cost of the taxman pursuing Arctic Systems Ltd over the controversial settlements legislation over the four year period.
2008 Changes - Income Shifting Proposals
The Government introduced its income shifting proposals after it was defeated in the Arctic Systems House of Lords case. Income shifting is the process by which an individual transfers part of their income (from dividends or partnership profits) to another person who is subject to a lower rate of tax. The Government intends to tax the shifted income as if it had been received by the higher tax payer. The new rules will come into effect in April 2008 after a consultation period. They have been widely criticised as being too complex and leaving significant areas of uncertainty. The Tax Faculty has attempted to clarify the proposals, with a proviso that the proposals are merely a consultation.
It says: "Very broadly, the rules will apply where under 'relevant arrangements' dividends or partnership profits are shifted from one individual (individual 1) to another individual (individual 2).
"The changes are meant only to affect those who transfer dividends or profits and as a
consequence move income from a higher to a lower rate taxpayer. The rules will apply where all of
the following conditions are met:
Condition A - individual 1 is party to or has power over the relevant arrangements; Condition B - individual 1 forgoes income, and the income forgone is individual 2's for the relevant tax year; Condition C - individual 1 has the power to control the amount that is shifted; and Condition D - the shifted income consists of distributions of a company or profits of a partnership.
"...Where the rules apply, the income is treated as forming part of the income of the individual shifting the income and not the income of the other individual."
