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CHANCERY DIVISION [1996] STC 743, 70 Tax Cas 331 HEARING-DATES: 13, 20 March 1996 20 March 1996 CATCHWORDS: Settlement — Meaning — Settlements between spouses — Gifts between husband and wife — Taxpayers directors and sole shareholders of trading company — Preference shares issued to taxpayers' wives — Wives not granted right to participate on a winding up of company — Substantial dividends declared and paid on preference shares — Whether an arrangement constituting a settlement — Whether a revocable settlement — Whether preference dividends to be treated as income of taxpayers — Outright gift by one spouse to the other — Whether property given was wholly or substantially a right to income — Income and Corporation Taxes Act 1988, ss 672, 674A(1), 681(4), 685(4A). HEADNOTE: The taxpayers were the sole shareholders and directors of P Ltd, an established, profitable trading company. They determined that part of the profits of P Ltd should be paid to their wives and, to that end, in November 1990 the share capital of P Ltd was reorganised into ordinary and preference shares. The preference shares carried the right to a dividend of 30% of the net profit of P Ltd for the relevant financial year (the ordinary shareholders receiving the balance, if any, of any dividend declared), but no right to participate in the surplus assets of P Ltd on a winding up beyond a return of the subscription price paid for the shares and no right to vote at general meetings. The ordinary shares were allotted equally between the taxpayers and the preference shares were allotted equally between the wives of the taxpayers. The Revenue raised assessments on the taxpayers in the alternative under ss 672a and 674A(1)b of the Income and Corporation Taxes Act 1988 on the basis that the dividends paid to the wives should be aggregated with the income of their respective husbands since the actions of the taxpayers amounted to an arrangement sufficient to create a 'settlement' as defined in s 681(4)c of the 1988 Act and that the income of the settlement was to be treated as the income of the taxpayers as settlors either (i) pursuant to s 672 because the settlement was revocable since the taxpayers as owners of all the voting shares in P Ltd had power to revoke the settlement by winding up P Ltd; or (ii) pursuant to s 674A(1) which deemed income payable under a settlement to be treated as that of the settlor unless, inter alia, the settlor had divested himself absolutely of the income under the settlement (s 674A(1)(d)) or the income of the settlement was treated as that of the settlor under another provision (s 674A(1)(f)). The Special Commissioner allowed the taxpayers' appeal holding that the dividends paid to the wives were taxable on each of them separately since the taxpayers' actions had not amounted to an arrangement sufficient to create a settlement, and further that the power of the taxpayers to wind up P Ltd at any time did not constitute power to revoke the alleged settlement within s 672 of the 1988 Act. The Crown appealed, contending, inter alia: (1) that the creation of a new class of preference shares, the application by the wife of each of the taxpayers for 25 of the new preference shares to be issued at par and the allotment of the shares together constituted an arrangement or disposition and therefore a 'settlement' within s 681(4) of the 1988 Act; and (2) that none of the exceptions excluding the application of s 674A(1) were relevant since the taxpayers were deemed not to have divested themselves absolutely of the preference shares within s 674A(1)(d) because the transaction was an outright gift by one spouse to the other of property which property was wholly or substantially a right to income within s 685(4A)d of the 1988 Act, and nor did the exception in s 674A(1)(f) apply because the only other provision under which the income of the settlement could have been treated as that of the settlors was s 672, which did not apply because there was no power to revoke the settlement. Held - (1) The creation of the new class of preference shares, the application by the wife of each of the taxpayers for 25 of the new preference shares to be issued at par and the allotment of the shares together constituted an arrangement or disposition within the meaning of the definition of settlement in s 681(4) of the 1988 Act. Copeman (Inspector of Taxes) v Coleman, for Coleman Minors (1939) 22 TC 594 followed. Dicta of Lord Macmillan in Chamberlain v IRC (1943) 25 TC 317 at 331 explained; dicta of Lord Greene MR in Hood-Barrs v IRC (1946) 27 TC 385 at 402 applied. (2) The preference shares entitled the holders to a preferential dividend if the taxpayers determined to distribute the whole or part of the profits arising in any given year. Apart from that right to income, the only rights conferred on the preference shareholders were the right to repayment of the nominal sum paid on the allotment of the shares and the right to attend and be heard, but not to vote, at general meetings. Section 674A(1) was not therefore excluded in the instant case, since the creation and allotment of shares was an outright gift of property from one spouse to the other comprising wholly or substantially of a right to income within s 685(4A), and therefore the taxpayers as settlors were deemed not to have divested themselves absolutely of the preference shares so that the income of the settlement was to be treated as income of the taxpayers. Furthermore, the treatment of the income of the preference shares as income of the taxpayers under s 674A(1) was not excluded by s 674A(1)(f) on the ground that it was so treated pursuant to a deeming provision other than s 674A, since the creation and allotment of the preference shares was not a settlement under which any person had power 'to revoke or otherwise determine the settlement or any provision thereof' within s 672, because there was an outright gift of the preference shares to the spouses. The preference dividends therefore fell to be treated under s 674A(1) as the income of the taxpayers. The Crown's appeals would therefore be allowed. NOTES: For the meaning of settlement, see Simon's Direct Tax Service C4.302. For settlements between spouses, see ibid, C4.383. For gifts between husband and wife, see ibid, E5.103B. For the Income and Corporation Taxes Act 1988, ss 672, 674A(1) (inserted by the Finance Act 1989, s 109(1)), 681(4), 685(4A) (inserted by the Finance Act 1989, s 108(4)), see ibid, Part G1. The Income and Corporation Taxes Act 1988, ss 672, 674A(1), 681(4), 685(4A) were repealed by the Finance Act 1995, Sch 29, Pt VIII(8) with effect from the year 1995-96, and replaced by Ch IA (ss 660A-660G) inserted by the Finance Act 1995, s 74, Sch 17, Pt I. CASES-REF-TO: Chamberlain v IRC [1943] 2 All ER 200, 25 TC 317, HL. Copeman (Inspector of Taxes) v Coleman, for Coleman Minors [1939] 2 KB 484, [1939] 3 All ER 224, 22 TC 594. Hood-Barrs v IRC [1946] 2 All ER 768, 27 TC 385, CA. IRC v Mills [1974] STC 130, [1975] AC 38, [1974] 1 All ER 722, 49 TC 367, HL. IRC v Morton 1941 SC 467, 24 TC 259, CS. IRC v Plummer [1979] STC 793, [1980] AC 896, [1979] 3 All ER 775, 54 TC 1, HL. CASES-CITED: Butler (Inspector of Taxes) v Wildin [1989] STC 22, 61 TC 666. Chinn v Collins (Inspector of Taxes) [1981] STC 1, [1981] AC 533, [1981] 1 All ER 189, 54 TC 311, HL. Crossland (Inspector of Taxes) v Hawkins [1961] Ch 537, [1961] 2 All ER 812, 39 TC 493, CA. IRC v Buchanan [1958] Ch 289, [1957] 2 All ER 400, 37 TC 365, CA. IRC v Payne (1940) 23 TC 610, CA. IRC v Prince-Smith [1943] 1 All ER 434, 25 TC 84. Wolfson v IRC [1949] 1 All ER 865, 31 TC 141, HL. INTRODUCTION: Appeal The Crown appealed against a decision of a Special Commissioner (T H K Everett) released on 25 May 1995 (see [1995] STC (SCD) 196) allowing the appeals of the taxpayers against assessments made in the alternative under ss 672 and 674A of the Income and Corporation Taxes Act 1988. The decision is set out below. DECISION Section 32 of the Finance Act 1988 abolished the aggregation of income between husbands and wives. I infer therefore that Mr Pearce and Mr Scrutton (the taxpayers) who were the sole directors and shareholders of a profitable trading company decided that they might reduce each of their liabilities to income tax by arranging for some of the profits of the company to be received by their wives and not by them. The Revenue allege that the actions of the taxpayers created settlements and have assessed each of the taxpayers to income tax for the years 1990-91 to 1992-93 inclusive pursuant to s 672 of the Income and Corporation Taxes Act 1988 and in the alternative pursuant to s 674A. The taxpayers, whose appeals were heard together by agreement, have each appealed against those assessments. The facts There is no dispute about the facts in these appeals which form the subject of a short agreed statement supported by agreed bundles of documents. The statement reads as follows. 1. At the first meeting of the Pearton Tooling Co Ltd (Pearton) held on 24 October 1977, the appellant, Nicholas Ronald Pearce (Mr Pearce) and the appellant Alan Scrutton (Mr Scrutton) were both present and it was resolved that Mr Pearce should be chairman of Pearton and Mr Scrutton should be secretary. It was further resolved that the taxpayers, who had each subscribed to Pearton's memorandum of association on 19 September 1977 and had undertaken to each take up one (£1) share out of Pearton's total share capital of £100 divided into 100 (£1) shares, should each be allotted one fully paid ordinary share of £1. At all material times the taxpayers were the only directors of Pearton. 2. On 14 November 1990 at an extraordinary general meeting of Pearton at which the taxpayers were present, it was resolved by special resolution that the articles of association of Pearton should be altered and that, inter alia, the following amendments should take effect: (a) that the share capital of Pearton should be divided into 50 preference shares of £1 and 50 ordinary shares of £1; (b) that the preference shareholders in relation to any distribution of profits to its shareholders, which Pearton might determine, would be entitled to a participating dividend equal to 30% of the net profit of Pearton and its subsidiaries (if any) for the relevant financial year and the ordinary shareholders would be entitled to receive the balance (if any) of the amount determined for distribution to its shareholders by Pearton; (c) that on a return of assets on liquidation of Pearton, the preference shareholders should receive the subscription price paid for their shares but no further right to participate in the surplus assets of Pearton which would belong to the ordinary shareholders; (d) and that the preference shareholders should be entitled to receive notices of and to attend and speak at general meetings of Pearton but not to vote. 3. Immediately after the holding of the extraordinary general meeting, a meeting of Pearton's directors took place to deal with the applications for shares in Pearton made by Mr Pearce, Mr Scrutton, Elizabeth Ann Pearce, the wife of Mr Pearce, and June Scrutton, the wife of Mr Scrutton, and on payment in full of amounts equal to the nominal value of their respective holdings by each allottee, the following allotments were made:
4. It is recorded in the financial statements of Pearton for the years ended 30 November 1990, 30 November 1991 and 30 November 1992 that the following distributions of dividends were made:
5. The net profit of Pearton for 1990 amounted to £73,869, for 1991 £74,646 and for 1992 £56,696. It will be seen therefore that the preference shareholders received dividends amounting to more than 30% of the net profit of Pearton for each of the three years in question but it is common ground in these appeals that the dividends received by Mrs Pearce and Mrs Scrutton in each of those years were not ultra vires the company. 6. In the assessments raised on the taxpayers, the Revenue have sought to treat the amounts of the dividends on their preference shares received by Mrs Pearce and Mrs Scrutton after the grossing-up of the amounts at the basic rate, as the income of Mr Pearce and Mr Scrutton respectively. 7. It is conceded by the taxpayers that the issuing of the preference shares to Mrs Pearce and Mrs Scrutton involved an element of bounty on the part of the taxpayers. The statutory provisions Section 672 provides, where relevant: '(1) If and so long as the terms of any settlement (wherever made) are such that -- (a) any person has or may have power, whether immediately or in the future, and whether with or without the consent of any other person, to revoke or otherwise determine the settlement or any provision thereof; and (b) in the event of the exercise of the power, the settlor or the wife or husband of the settlor will or may become beneficially entitled to the whole or any part of the property then comprised in the settlement or of the income arising from the whole or any part of the property so comprised, any income arising under the settlement from the property comprised in the settlement in any year of assessment ... shall ... be treated for all the purposes of the Income Tax Acts as the income of the settlor for that year and not as the income of any other person.' Section 674A(1) provides, where relevant: 'Where, during the life of the settlor, income arising under a settlement is, under the settlement and in the events that occur, payable to or applicable for the benefit of any person other than the settlor, then, unless, under the settlement and in those events, the income -- ... (d) is income from property of which the settlor has divested himself absolutely by the settlement ... the income shall be treated for all the purposes of the Income Tax Acts as the income of the settlor and not as the income of any other person.' It is also necessary to look at other provisions of the 1988 Act: (i) in s 681(1), the expression 'income arising under a settlement' is stated to include '(a) any income chargeable to income tax by deduction or otherwise'; (ii) in s 681(4), the expression 'settlement' in Ch III is stated to include 'any disposition, trust, covenant, agreement or arrangement'. Conclusions I do not rehearse at length the contentions of the parties as Mr James and Mr Cotton each provided me with a typed skeleton which will be available for the court should these appeals proceed further. Briefly Mr Cotton contended in relation to s 674A that the actions of the taxpayers amounted to an 'arrangement' within the definition of 'settlement' provided by s 681(4). Mr James contended on the facts and on the law that the actions of the taxpayers did not amount to an arrangement sufficient to create a settlement within the provisions of s 674A. In relation to s 672, Mr Cotton contended that, as the taxpayers as the owners of all the voting shares in Pearton had power at any time to wind up Pearton, they had retained power to revoke the alleged settlement in favour of Mrs Pearce and Mrs Scrutton. Mr James, once again, contends otherwise. As I have said earlier, I infer that there was an intention on the part of the taxpayers in 1990 to provide that part of the profits of Pearton should be paid to Mrs Pearce and Mrs Scrutton rather than to the taxpayers, in the belief that the results of those actions would be beneficial to the taxpayers and their wives from the point of view of income tax. The question which I have to decide is whether the actions of the taxpayers amounted to an arrangement, such as to create a settlement, and, if so, whether any such settlement was revocable within the terms of s 672. It is common ground that the assessments pursuant to s 672 and those pursuant to s 674A have been made in the alternative. The main plank of the Revenue's case is that the actions of the taxpayers in 1990 and subsequently amounted to an arrangement. Mr Cotton points first to the joint action of the taxpayers at the extraordinary general meeting of Pearton on 14 November 1990 in causing Pearton by special resolution to adopt new articles; secondly the joint action of the taxpayers at a directors' meeting held immediately after the extraordinary general meeting in making allotments of preference shares to their wives on payment by them of the nominal value of the shares; thirdly the action of the taxpayers as directors of Pearton in recommending the payment of the dividends in each of the relevant years to Mrs Pearce and Mrs Scrutton and fourthly the action of Pearton, when controlled by the taxpayers, through its general meeting in declaring, in each of the financial years ended 30 November 1990 to 30 November 1992 inclusive, dividends to its shareholders. Both parties have placed reliance on dicta obtained from Chamberlain v IRC (1941) 25 TC 317. Mr Cotton relies on an extract from the judgment of du Parcq LJ (at 323). But the decision of the Court of Appeal in favour of the Revenue was reversed in the House of Lords and accordingly I accept Mr James's contention that Lord Macmillan's view of the law is to be preferred to that of du Parcq LJ. In his speech Lord Macmillan said (at 331): 'I find myself unable to agree with the Crown's contention. I accept the view that the statutory expansion of the term "settlement", which includes an "arrangement", justifies and, indeed, requires a broad application of Section 38 of the Act of 1938 , but a settlement or arrangement to come within the Statute must still be of the type which the language of the Section contemplates. I agree with Lord Moncrieff that the settlement or arrangement must be one whereby the settlor charges certain property of his with rights in favour of others ... It must comprise certain property which is the subject of the settlement; it must confer the income of the comprised property on others, for it is the income so given to others that is to be treated as nevertheless the income of the settlor.' That statement was approved by Lord Wilberforce in his speech in IRC v Plummer [1979] STC 793 at 801, [1980] AC 896 at 912. The word arrangement enlarges the ambit of the word settlement but having considered the submissions of the parties and the authorities to which I have been referred and in particular the statement of Lord Macmillan, I am far from convinced that the actions of the taxpayers amounted to an arrangement sufficient to create a settlement. Unlike taxpayers in many of the other authorities quoted they did not create a new vehicle for their intentions. Pearton was a successful trading company which had been in existence for some 13 years before 1990. Although Mr Cotton was able to refer me to the case of IRC v Prince-Smith (1943) 25 TC 84, where the use of an existing company had formed part of an arrangement the facts of that case are far removed from the facts of the instant case. I am also inclined to accept the contention of Mr James that the Revenue's assertion that the declaration and payment of the dividends constitute part of the arrangement is misconceived, as I do not understand how the dividends can be both an intrinsic part of the alleged settlement and the income of the settlement, as is alleged. In my judgment the actions of the taxpayers did not amount to an 'arrangement' sufficient to create a settlement. That is sufficient to determine the appeals in favour of the taxpayers, but I will also deal with the question of revocation in relation to the assessments raised pursuant to s 672. In my judgment the power of the taxpayers to wind up Pearton at any time does not constitute power to revoke the alleged settlement. The company was not established as part of the taxpayers' actions intended to benefit their wives: it was an established profitable trading company. Its existence was not a term of any alleged settlement and the power of the taxpayers to wind up Pearton is, in my view, outwith the provisions of s 672. The appeals succeed and I quash each and every one of the assessments. COUNSEL: Michael Furness the Crown; Alun James for the taxpayers. JUDGMENT-READ: Cur adv vult 20 March. The following judgment was delivered. PANEL: SIR JOHN VINELOTT (SITTING AS A JUDGE OF THE HIGH COURT) JUDGMENTBY-1: SIR JOHN VINELOTT JUDGMENT-1: SIR JOHN VINELOTT. These are appeals by the Crown from a single decision of one of the Special Commissioners, Mr T H K Everett (see [1995] STC (SCD) 196). The facts are not in dispute and can be briefly stated. Pearton Tooling Co Ltd (the company) was incorporated in 1977. The taxpayers, Mr Nigel Ronald Pearce and Mr Alan Scrutton, were the subscribers to its memorandum and articles. Each was allotted one share of £1 out of an authorised capital of 100 £1 shares. They were appointed and have since remained the only directors, Mr Pearce being the chairman and Mr Scrutton the secretary. On 14 November 1990 an extraordinary general meeting of the company was held and new articles of association were adopted. Under the new articles the share capital was divided into two classes: 50 preference shares of £1 each and 50 ordinary shares of £1 each. The preference shareholders are given the right, in the event that the company should resolve to distribute any part of its profits for any year, to a dividend equal to 30% of the net profits of the company for that year. The balance of the profits which the company resolves to distribute are then to be paid to the holders of the ordinary shares. On the liquidation of the company the preference shareholders are entitled to repayment of the sums subscribed for their shares, and no more. They are entitled to attend and to speak but not to vote at general meetings of the company. Immediately after the meeting at which these new articles were adopted there was a meeting of the board of directors of the company at which an application by each of the taxpayers for a further allotment of 24 ordinary shares at par and an application by the wife of each taxpayer for allotments of 25 preference shares at par were approved. Subsequently, the company resolved to distribute £100,000 in respect of profits for the year to 30 November 1990, £60,000 in respect of profits for the year to 30 November 1991 and £60,000 in respect of profits for the year to 30 November 1992. The dividends paid on the preference shares were £60,000, £40,000 and £36,000 respectively. It seems that the sums paid to the preference shareholders were slightly more than 30% of the net profits of the company in respect of each of those years, but it is not suggested that the payments were invalid. The question is whether the dividends paid to each preference shareholder should be aggregated with the income of her husband or are taxable as her separate income under the regime for separate assessment introduced by the Finance Act 1988, with effect from 6 April 1990. Two questions have to be answered separately in relation to each taxpayer. The first is whether the creation of a new class of preference shares, the application by the wife of each of the taxpayers for 25 of the new preference shares to be issued at par and the allotment of the shares together constitute an arrangement or disposition within the definition of 'settlement' in s 681(4) of the Income and Corporation Taxes Act 1988 (the 1988 Act). It is not in contention that if that question is answered in the affirmative then, in relation to each taxpayer, the 'funds' provided by him comprised the preference shares issued to his wife. The second question, which arises only if the first is answered in the affirmative, is shortly as follows. The 'income arising under ... the settlement' when it arose was 'payable to or applicable for the benefit of [a] person other than the settlor' and so fell within s 674A(1) of the 1988 Act, as inserted by s 109(1) of the Finance Act 1989. Accordingly, it is to be treated for all the purposes of the 1988 Act as the income of the settlor unless it falls within one of the exceptions in sub-paras (a) to (f) of s 674A(1). The only relevant sub-paragraph is (d) -- '... income from property of which the settlor has divested himself absolutely by the settlement'. Sub-paragraph (f) excepts -- '... income which, by virtue of any provision of the Income Tax Acts other than this section, is to be treated for all the purposes of those Acts as income of the settlor ...' The only other provision which could have that effect is s 672. For reasons which will appear later, if the creation and allotment of the preference shares did amount to a 'settlement' in respect of which each taxpayer was a 'settlor' of the preference shares taken by his wife, the settlement was not one under which any person had power 'to revoke or otherwise determine the settlement or any provision thereof' within s 672(1). Returning to s 674A(1), by the joint effect of sub-s (3) and s 685(1), a settlor -- '... shall not be deemed to have divested himself absolutely of any property if that property or any derived property is, or will or may become, in any circumstances whatsoever, payable to or applicable for the benefit of the settlor or ... the wife or husband of the settlor.' That must now be read in conjunction with a group of subsections introduced by s 108(4) of the Finance Act 1989, of which I need read only the first two subsections: '(4A) References in section 683 to a settlement do not include references to an outright gift by one spouse to the other of property from which income arises unless -- (a) the gift does not carry a right to the whole of that income, or (b) the property given is wholly or substantially a right to income. (4B) For the purposes of subsection (4A) above a gift is not an outright gift if it is subject to conditions, or if the property given or any derived property is or will or may become, in any circumstances whatsoever, payable to or applicable for the benefit of the donor.' Under s 674A(3) these subsections have effect for the purposes of the year 1990-91 and subsequent years. After this detour, I can now return to the second question in this appeal, which is whether, if the creation and allotment of these shares constituted a 'settlement' for the purposes of s 674A(1) (as modified by s 685(1)), the allotment of these shares is none the less excluded from s 674A(1) by s 685(4A). In my judgment, there can be no doubt as to the correct answer to the first question. The relevant facts in Copeman (Inspector of Taxes) v Coleman, for Coleman Minors [1939] 2 KB 484, 22 TC 594 are summarised in the following passage in the judgment of Lawrence J ([1939] 2 KB 484 at 491, 22 TC 594 at 599) -- '... in 1935 a company was formed by the respondent to take over his business with a capital of £1,000 in £1 shares which were equally held by the respondent and his wife. On March 18, 1937, at an extraordinary general meeting the capital of the company was increased to £6,000, and it was provided that twenty-five preference shares should be created of £200 each, entitled to a 10 per cent. preferential dividend and to participate with the ordinary shares equally in the surplus. These preference shares were allotted to the relations of the respondent and his wife, and two of them to their two children in consideration of a payment of £10 each in cash. By this issue of shares, therefore, the company obtained £250 capital. On March 31, 1937, a dividend of 20 per cent. was declared, free of tax, and each of the respondent's children received the sum of £40. At the same time a resolution was passed to call up £40 per preference share. Claims were then put forward by the respondent for return of the tax on the sum of £40 for each of the children.' The question in that case was whether the creation and allotment of the shares to the children constituted a 'settlement' for the purposes of s 21 of the Finance Act 1936 under which income paid to or applied for the benefit of a child of a settlor while an infant and unmarried fell to be treated as the income of the settlor. Subsection (9) defined 'settlement' as including -- '... any disposition, trust, covenant, agreement, arrangement or transfer of assets' and 'settlor' as -- '... any person by whom the settlement was made or entered into directly or indirectly, and ... includes any person who has provided or undertaken to provide funds directly or indirectly for the purpose of the settlement ...' Lawrence J, reversing the decision of the General Commissioners, said ([1939] 2 KB 484 at 494, 22 TC 594 at 601): 'In my opinion, it is impossible to come to any other conclusion but that this was not a bona fide commercial transaction, and it appears to me that there was a "disposition" within the meaning of the definition in sub-s 9, or "an arrangement" in the nature of a "disposition" within the meaning of that sub-section. I am also of opinion that the respondent was a settlor within the meaning of clause (c). I am unable to see how the word "indirectly" can be limited in the way which is suggested so as to exclude the settlements which are made through the interposition of a company.' The definition of 'settlement' for the purposes of s 21 of the 1936 Act differs from the definition in s 681(4) of the 1988 Act only in that the words 'transfer of assets' are omitted from the latter subsection. Those words were first omitted in the anti-avoidance provision introduced in 1938 (which includes the predecessor of s 672), no doubt because they were regarded as unnecessary. It is impossible to conceive of circumstances in which a transfer of assets would not also amount to a disposition. Further, it is impossible to suppose that the draftsman intended the definition of 'settlement' in the 1938 legislation to have a narrower scope than that in s 21, and Lawrence J did not rely on those words. Copeman (Inspector of Taxes) v Coleman is in my judgment conclusive of the first question in favour of the Crown. The Special Commissioner, who decided the first question in favour of the taxpayers, was not referred to Copeman (Inspector of Taxes) v Coleman. He was persuaded to take a different view by an argument founded on an observation of Lord Macmillan in Chamberlain v IRC (1943) 25 TC 317. The claim in that case was made under s 38(2) of the Finance Act 1938, the predecessor of s 672. Under that subsection, so far as material, income arising under a settlement is to be treated as 'the income of the settlor ... and not as the income of any other person' if -- '... (a) any person has or may have power, whether immediately or in the future, and whether with or without the consent of any other person, to revoke or otherwise determine the settlement or any provision thereof; and (b) in the event of the exercise of the power, the settlor or the wife or husband of the settlor will or may become beneficially entitled to the whole or any part of the property then comprised in the settlement or of the income arising from the whole or any part of the property so comprised.' The facts in Chamberlain v IRC are complex. The 'brief risumi' in the speech of Lord Thankerton occupies a full page of the report. It is sufficient to say that the taxpayer created four settlements, one for each of his infant children, and the sums settled were then invested in the purchase of shares in an investment company, Staffa Investment Trust. That company, in turn, held shares of a trading company, Commercial Structures Ltd, which were owned by the taxpayer and his brother. The four settlements were irrevocable and none of the income was paid to or applied for the benefit of the infant children during the relevant years of assessment. So, to bring the case within s 38 the Crown had to establish that the 'income arising under the settlement' was the income of the investment company and that 'the property comprised in the settlement' was the property held by that company (see per Lord Thankerton (at 329)). The House of Lords unanimously rejected this claim. Lord Thankerton (with whose speech Lord Simon and Lord Atkin agreed) said (at 329): 'I may premise that, in seeking the due application of Section 38 of the Finance Act of 1938, each case is apt to depend on its own facts, and other cases are not likely to be of material assistance. Further, it seems to me that, while the word "settlement" is defined in the widest terms, the more crucial point is likely to be the determination of what the "property comprised in the settlement" consists of in the particular case. The present case affords, in my opinion, a good illustration of this point, and the question may be thus stated. Did the property comprised in the settlement consist of the whole assets of Staffa, or is the property comprised in the settlement to be found separately comprised in each of the five deeds of settlement, the formation of Staffa being part of the arrangement conceived by the Appellant, whereby a convenient and profitable investment was made available for the moneys respectively settled under the five deeds of settlement? My Lords, I am of opinion that the latter alternative provides the correct view of the arrangement made by the Appellant, with a view to making provision for his children. While the formation of Staffa provided an available investment for the sums settled under the five deeds of settlement, under which the children's provisions were actually constituted, the continuance of such investment was not essential to the continuance of the trusts under the deeds of settlement. In other words, the sums settled under these deeds were the funds provided for the purpose of the settlement within the meaning of Section 41(4)(c). Staffa, though controlled by the Appellant, did not, in my opinion, hold its assets as part of the provisions settled on the children. I am of opinion that the whole assets of Staffa did not constitute the property comprised in the settlement, and that the assessment cannot stand.' Lord Romer agreed that the property comprised in the statutory settlement (to use a convenient abbreviation) did not comprise the assets of Staffa and that it could not include the constitution of Staffa. He said (at 334): 'Although, therefore, it may be possible to say, in view of Section 41(4)(b) of the Finance Act, 1938, that on 10th March, 1936, there came into existence a compound settlement in the form of an arrangement consisting of the forming of Staffa, the agreement for the sale to it of the 470 shares in Commercial Structures, Ltd, the trust deed of that date and the subscription by the trustees of 350 ordinary shares, the property comprised in that settlement consisted of nothing but the last-mentioned shares. It did not and could not consist of the whole of the assets of Staffa, or even the 470 shares in Commercial Structures, Ltd that Staffa held, any more than a subsequent settlement such as I have mentioned would or could have done. The Appellant had an interest in all such assets as the holder of preference shares, and the holders of any subsequently issued preference shares and of all ordinary shares whenever they might have been issued would also be interested in such assets regardless of the date of their issue and of the date of any settlement of which they might be the subject-matter.' It is in this context that the observations of Lord Macmillan relied on by the Special Commissioner must be understood. Lord Macmillan (at 331) stated the contentions of the Crown to be -- '... that the formation and structure of the Staffa Investment company, together with the sale agreement of 23rd December, 1935, the settlement of 10th March, 1936, and the four settlements of 7th December, 1936 "constitute an arrangement and a settlement within Section 41(4)(b), Finance Act, 1938".' He rejected that contention (at 331-332) in these terms: 'I accept the view that the statutory expansion of the term "settlement", which includes an "arrangement", justifies and indeed requires a broad application of Section 38 of the Act of 1938, but a settlement or arrangement to come within the Statute must still be of the type which the language of the Section contemplates. I agree with Lord Moncrieff that the settlement or arrangement must be one whereby the settlor charges certain property of his with rights in favour of others (Commissioners of Inland Revenue v. Morton [1941 SC 467 at 480, 24 TC 259 at 269]. It must comprise certain property which is the subject of the settlement; it must confer the income of the comprised property on others, for it is the income so given to others that is to be treated as nevertheless the income of the settlor. There can be no question that the deeds of 10th March, 1936, and 7th December, 1936, were settlements. Each of them settled a sum of money provided by the settlor and provided for the application of the income for the benefit of third parties, although the four settlements of 7th December, 1936, because of their irrevocability do not fall within Section 38. But none of these settlements comprised any property of the Staffa Investment company. The trust funds were invested in shares of that company, which is quite a different matter. In point of fact, the whole assets of the company have never been settled at all so as to dedicate the whole of its income to any trust purposes. But it is said that the "formation and structure" of the company was just a part of an "arrangement" which must be looked at as a whole and which, when so looked at, is seen to be a settlement of the company's whole assets, namely, the 470 shares of Commercial Structures, Ltd, which originally belonged to the Appellant. I am prepared to agree that the creation of the Staffa Investment company and its very special constitution were essential steps towards the effecting of the Appellant's object. So no doubt was the sale to the company of his 470 shares in Commercial Structures, Ltd. But that sale was for consideration in money or money's worth, and resulted, inter alia, in the Appellant receiving 35,000 preference shares of the Staffa Investment company for himself, the income of which he has himself enjoyed. How can it be said that the whole assets of the Staffa Investment company have been comprised in a settlement by the Appellant when he himself retains a substantial interest in the company which has never been the subject of a settlement at all? The most attractive way of presenting the Crown's case is to characterise the whole transaction as a single scheme which begins with 470 shares in Commercial Structures, Ltd in the hands of the Appellant as his personal property, and after much manoeuvring ends with the income from these shares no longer payable to himself but settled in favour of third parties. He who wishes the end wishes the means. This, however, is not, in my opinion, an accurate legal presentation of the matter, which requires a much closer analysis. I have already pointed out that the Appellant has never settled the whole of the shares in the Staffa Investment company. And further shares might still be issued. It is, I think, fallacious to confuse the steps taken by the Appellant with a view to effecting a settlement or arrangement with the settlement or arrangement itself.' A little later he added (at 332): 'It is essential to the Crown's case that it should make out that the whole assets of the Staffa Investment company are comprised in a settlement or arrangement made by the Appellant within the meaning of the Statute. In my opinion the Crown has failed to establish this.' Hood-Barrs v IRC (1946) 27 TC 385 was another case brought in reliance under s 21 of the 1936 Act. The precise facts are not material. One of the contentions advanced on behalf of the taxpayer was (at 400) that -- '... the transfer of assets, to fall within the meaning of the interpretation clause, must be something in the nature of a settlement in the ordinary meaning of that word.' The point was put in slightly different terms by leading counsel, Serjeant Sullivan, who said (at 401) -- '... if you find in the word "settlement" in Section 21(1) something of doubtful import, you then turn to the interpretation clause to see whether that clause throws any light upon it.' Commenting on those submissions, Lord Greene MR set out part of the passage from the speech of Lord Macmillan which I have read and continued (at 402): 'That has been read as though it meant this, that a settlement or arrangement to come within the statute must still be of the type which the word "settlement" in the Section contemplates. With all respect I think it cannot mean that. If I may say so with the utmost respect, I cannot bring myself to believe that Lord Macmillan intended to make a suggestion as to the meaning and operation of such an interpretation clause so subversive as that which Serjeant Sullivan argues for. If by any chance that were the meaning of his words, I hope I shall not be thought disrespectful if I say that I would not, sitting in this Court, accept that as binding upon me. But those words at the most are merely dicta of one of the noble and learned Lords. The argument as presented by Serjeant Sullivan, in my opinion, does scant justice to Lord Macmillan, because, as I read Lord Macmillan's observation, it is not more than this: Where you find a word which is interpreted in an interpretation clause, you must look at the Section as a whole and see what is the true interpretation in the whole of the context, namely, the whole of the Section as related to the type of document with which the Section is dealing. You may limit the meaning of the interpretation clause by reference to that context, as indeed you may limit the meaning of any word by reference to the context. But it certainly does not, in my opinion, mean that when you look at the word "arrangement" in the interpretation clause -- that was the word which was in issue in that case -- you are to limit the scope of that word by reference to the one word "settlement" in regard to which the interpretation clause is made.' In IRC v Plummer [1979] STC 793 at 801, [1980] AC 896 at 912-913 Lord Wilberforce said: 'The courts which, inevitably, have had to face this problem, have selected the element of "bounty" as a necessary common characteristic of all the "settlements" which Parliament has in mind. The decisions are tentative, but all point in this direction. The first clear indication of this was given by Lord Macmillan in Chamberlain v IRC (1943) 25 TC 317 at 331. Dealing with a case arising under the predecessor of s 447 of the 1970 Act he said that he agreed that the settlement or arrangement -- "... must be one whereby the settlor charges certain property of his with rights in favour of others ... it must confer the income of the comprised property on others, for it is this income so given to others that is to be treated as, nevertheless, the income of the settlor." I do not think that this passage is affected by the observations of Lord Greene MR in Hood Barrs v IRC (1946) 27 TC 385.' In IRC v Plummer the question was whether the transaction was a commercial one and lacked the element of 'bounty' which was a necessary ingredient for an arrangement to be treated as constituting a settlement. I can see nothing in the observations of Lord Wilberforce which supports the view that the creation and allotment of the preference shares in this case, or in Copeman (Inspector of Taxes) v Coleman, cannot be brought within the definition of a settlement as being an arrangement or disposition containing the necessary element of bounty. That question was not before the House. I observe that Copeman (Inspector of Taxes) v Coleman (which was cited and approved by Viscount Dilhorne in IRC v Mills [1974] STC 130 at 134, [1975] AC 38 at 51) was not referred to in Chamberlain v IRC, no doubt because it was thought to be irrelevant to the question before the House, namely, whether the assets of Staffa Investments could be treated as the property comprised in, and as part of, a statutory settlement for the purposes of s 38 of the Finance Act 1938. I turn, therefore, to the second question. If the creation and allotment of the preference shares constituted a settlement, the subject matter of which was the preference shares allotted to the wife of each of the taxpayers, it must follow that the allotment of the preference shares taken by each wife was an outright gift from which income (the dividends paid on the preference shares) arose. It was not subject to conditions, and it cannot be said that the property given might 'become, in any circumstances whatsoever, payable to or applicable for the benefit of' the settlor/spouse within sub-s (4B). The gift of the preference shares was a gift which carried the right to the whole of that income, that is, the income which arose from the preference shares within sub-s (4A)(a). Was the 'property given' -- the preference shares -- 'wholly or substantially a right to income'? It seems to me that the answer to that question must be in the affirmative. The preference shares entitled the holders to a preferential dividend if the taxpayers (the only directors and the holders of all the ordinary shares) determined to distribute the whole or part of the profits arising in any given year. Apart from that right to income, the only rights conferred on the preference shareholders were the right to repayment of the nominal sum paid on the allotment of the shares and the right to attend and be heard, but not to vote, at general meetings of the company. As a matter of strict legal principle, the preference shares were assets distinct from the income derived from them, but in reality they could never have been realised. The income was dependent upon the taxpayers determining to distribute part of the profits of the company. Mr Furness, who appeared for the Crown, put forward two alternative contentions. The first was that the statutory settlement could be taken as comprehending the creation and allotment of the preference shares, together with the declaration of dividends. Thus, the property given outright consisted of the dividend and that was a gift which consisted wholly of income. Secondly, he submitted that the arrangement was a reciprocal arrangement between the two taxpayers and their respective wives and that s 685(4A) could not apply where property was given by two settlors to their respective wives. These alternative submissions seem to me to face considerable difficulties. It is natural to regard the preference shares as the funds provided by the taxpayers for the benefit of their respective wives and the income as income arising under the statutory settlement of those shares. As regards the second submission, prima facie the fund provided by each taxpayer under reciprocal arrangements comprised the preference shares allotted to his wife. However, as I have reached the clear conclusion that these appeals succeed upon the more straightforward ground, I do not propose to express any concluded opinion on the alternative submissions. In my judgment, therefore, the appeals must be allowed. DISPOSITION: Appeals allowed with costs. SOLICITORS: Solicitor of Inland Revenue; Robbins Olivey, Woking. |
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