The Famous Arctic Systems Case

The circumstances behind The Famous Arctic Systems Case dispute were not complicated: Mr Jones and his wife had equal ownership in the company known as Arctic Systems Limited. Mr Jones served as the business’s only director, while Mrs. Jones holds the position of the company secretary. The husband provided computer consulting services, while Mrs. Jones provided company secretarial and administrative services. Both the husband and wife occasionally received equal payments of small salaries from the company and substantial dividends.

The main question was whether the dividends paid to Mrs Jones were income from a settlement of which Mr Jones was the settlor, constituting those his income under ITTOIA 2005, s. 624. Arctic Systems Limited was established by company formation agents on August 5 1992, as an “off the shelf” company with two £1 shares. On August 11, 1992, Mr and Mrs Jones became the company’s new owners. Both Mr and Mrs Jones paid £1 to the total cost of their share. There were no updates to the company’s issued share capital, shareholdings, or officers after those first announcements were made.

Assessments were initially issued by HMRC for Mr Jones for the years 1996–1997 to 1999–2000; however, HMRC retracted the assessments for the first three years only three days before the appeals were to be considered by the special commissioner. As a result, the primary year being challenged is the 1999–2000 tax year, during which Mr Jones received a salary of £6,520, Mrs Jones received a salary of £3,600, and both received dividends amounting to £25,767, respectively.

In June 2004, two special commissioners, Dr Nuala Brice and Judith Powell heard the appeal, which was considered a “test case” for HMRC. However, the special commissioners’ decision was flawed. Dr Brice found HMRC and Judith Powell the appellant at the end of the appeal because the two special commissioners reached different conclusions. In this case, the special commissioner presiding over the hearing utilised the seldom invoked “casting a vote” procedure to break the tie.

The taxpayers filed an appeal against the decision made by the special commissioners, and Park J. heard the case in the High Court. The judgement was handed down on April 27, 2005. The judge sided with the special commissioner, and the taxpayers lost the appeal. Park J’s analysis of the charging section’s language states that “The reference… to a settlement does not include an outright gift by one spouse to the other of property from which income arises, unless… the property given is wholly or substantially a right to income,” supported his judgement to rule against the taxpayer.

The taxpayers contested this decision, and the Court of Appeal heard the case at the end of November 2005. The court reversed all prior taxpayer judgments (by a unanimous decision). It appeared that the judges generally agreed with the list of issues provided by the special commissioners.

HMRC had to apply to the House of Lords after the Court of Appeal denied leave to appeal. On July 25, 2007, the Lords ruled in favour of the taxpayer, ruling that “the arrangement did fall within the settlements legislation as the arrangement had the necessary element of bounty: the taxpayer’s wife could not have been issued with a share without the taxpayer’s agreement, and as part of the arrangement it was expected that he would take a low salary and substantial dividends would be paid, but the statutory let-out for outright sale did not apply.”

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