TT51: Settlements Legislation

The recent Budget brought into focus the potentially very nasty Settlements legislation. This little-used legislation has been in existence for a number of years but it is becoming increasingly clear that the Inland Revenue is now seeking to use it in a more aggressive way as a means of blocking commonplace tax saving strategies.

What does it mean?

The idea behind the Settlements legislation is quite simple. It operates in certain circumstances to treat income receivable by one person as belonging to another person (“Mr A”) for income tax purposes. The circumstances when this legislation applies are when a “Settlement” has been made by Mr A and he personally, or his spouse, or his minor, unmarried child benefits from it.

The expression “Settlement” is very wide and includes not only formal trusts and dispositions, but also transfers of assets and “arrangements”.

However, the Courts have held that a Settlement cannot exist for tax purposes unless there is an element of bounty. Thus, a sale of assets from one person to another at full value is not a Settlement for tax purposes.

Given the above, a gift of an asset from a husband to his wife would constitute a Settlement, and any income arising would therefore remain taxable on the husband; but when the rules concerning the independent taxation of husbands and wives were introduced in 1990, straightforward inter-spouse gifts of assets were specifically exempted.

Regrettably though, the Inland Revenue is trying to argue that frequently the transaction is not just a straightforward gift and that other ‘arrangements’ are present. The main focus is where the asset gifted is a block of shares in a closely controlled company in respect of which it is intended to declare dividends.

Can it be avoided?

A way round the problem has been for husband and wife couples nominally to own assets jointly, but without effecting any transfer of the underlying beneficial ownership of the asset. In such cases, there will have been no gift and, therefore, no Settlement, thus the Inland Revenue has been obliged to tax income arising on a 50:50 basis.

Unfortunately in the Budget the Chancellor announced that such a joint ownership arrangement would cease to apply from 6 April 2004. Mercifully, the tax treatment of jointly owned assets other than shares in closely controlled companies is unaffected.

Barnes Roffe Topical Tips

  • Jointly owned sharearrangements entered into to side-step the Settlements legislation must be reviewed and alternative strategies implemented.
  • If shares are owned jointly with your spouse, consider paying a large dividend on or before 5 April 2004 so as to avoid the new rules announced in the Budget.
  • Consider owning non-share assets jointly with your spouse without effecting any transfer of beneficial ownership so as to spread the income tax liability whilst avoiding a Settlement.
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