People who complain about paying their income tax can be divided into two types: men and women.

Finally we have it. The long awaited House of Lords ruling on Jones v Garnett – otherwise known as the Arctic Systems Ltd case.

The good news is that the Law Lords agree that the Revenue had no right to tax Mr Jones as if his wife’s dividend income were his own. A conclusion that most right thinking individuals who knew the facts of the case had already drawn in 2004, when Dr Nuala Brice bizarrely used her casting vote as chairperson at the Special Commissioners hearing and found in favour of the Revenue.

The bad news is that the Treasury has announced that it will consider amending the law so that in future cases the Revenue can do this without fear of challenge from the judiciary.

For those of you who are not so familiar with this case, here is a brief summary.

In 1992 Geoffrey and Diana Jones set up a company called Arctic Systems Ltd, and on the advice of their accountants subscribed to one £1 share each. Geoffrey was the only income producer in the company, and his wife dealt with administration. Both were employed by the company as well as being shareholders. As is quite common in a small, family business, in some years Geoffrey took a salary well below what might reasonably be regarded as the market rate. In those years a dividend was declared and this was, naturally, shared equally by Geoffrey and Diana as they were equal shareholders. The Revenue claimed that this arrangement meant that Geoffrey was effectively transferring some of his income to his wife, and that this was caught by Section 660A of the Income and Corporation Taxes Act 1988.

Supported by the Professional Contractors Group, Mr & Mrs Jones took their case to the Special Commissioners. Two commissioners sat, the junior of whom found in favour of the taxpayers, but Dr Nuala Price, who was the chairperson, found in favour of the Revenue and decided to ignore the opinion of her colleague.

The case went to the High Court, where Mr Justice Parks upheld the Special Commissioners ruling for the Revenue. It was then taken to the Appeal Court, where Lord Justice Keene ruled in favour of the taxpayers. Finally, this year, the case was taken by the Revenue to the House of Lords, where Lords Hoffman, Hope, Walker and Neuberger, and Baroness Hale unanimously found in favour of Mr and Mrs Jones and against the Revenue.

The ruling by the Law Lords confirmed that the Revenue were right to suggest that the way in which the company was set up was indeed an arrangement likely to be used to reduce the overall tax bill. Even though superficially it looks like a normal arrangement, with two shareholders putting in equal investments to acquire equal shareholdings, the argument is that it is most unlikely Mr Jones would have allowed anyone other than his wife to acquire half the value of the business, whose income derived entirely from his own efforts, for an investment of only £1.

Where the Law Lords differed from the previous rulings is that they accepted the argument that the exemption under Section 660A for an outright gift from one spouse to another applied in this case. It had previously been argued that this exemption could not apply as there was no gift – both taxpayers had purchased the shares with their own money. However, the Law Lords, quite reasonably, have now ruled that the Revenue cannot on the one hand argue that there has been a gift of income from Mr to Mrs Jones, but on the other hand state the spousal exemption does not apply as there has been no gift. I am no lawyer, but to my way of thinking this is faultless logic and I am surprised it has not been applied before the case got all the way to the House of Lords.

In summary:

• Before Arctic Systems it was generally understood that husbands and wives could share the income from their business however they wished, simply by issuing each other the right number of shares – provided they did not try to be too clever by using special categories of share with limited rights etc
• Arctic Systems introduced doubt that dividend income could be divided as required between spouses without possible penal tax consequences, even when ordinary shares without any special restrictions were used


• The House of Lords decision puts us right back to our first understanding – if you want to issue ordinary shares to your spouse in order to share the dividend income, this should not be a tax problem
• But be aware that if you are looking at an aggressive dividend strategy to transfer income to your spouse this year, there may be a change in legislation shortly which could outlaw this.