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HMRC took another Company to court recently on the grounds of income shifting.

After HMRC lost the now famous Arctic Systems case, it tried to push through a law on income shifting, which fell out of both budgets this year and has been moved to the back burners. This does not appear to have stopped HMRC trying, so they put Patmore vs. HMRC through the courts.

Mr Patmore worked for a company and owned 15% of the shares. The original director retired, so Mr Patmore (hereafter Mr) and Mrs Patmore (Mrs) remortgaged their house to buy the last 85%. Mrs took 2 shares and Mr had 83 of the 85, making his total 98. They reclassified these shares as A shares and set up a B class issuing all 10 shares to Mrs.

HMRC argued that the B dividends should be taxed on Mr as a settlor. During the case, a table of all the dividends paid to the couple on both the A and B shares, was presented and this showed that 41.7% of the total dividends had been paid to Mrs, despite holding only 12 shares of 110.

The judge held that as they had remortgaged their home, Mrs was responsible for half of the financing (on the 85 shares), and was therefore entitled to half (of the 85%, so 42.5%) of the income. 41.7% is actually less than she was entitled to. The shares were therefore not settled on her and it was not a ‘bounteous arrangement’.

An extra argument by HMRC was that she wasn’t even receiving the dividends, as they were going to Mr’s Director’s Current Account to keep it in credit. Of course, the drawings against this account had been used to fund their joint lifestyle and repay the mortgage, so HMRC lost this argument too.

Despite losing Arctic Systems, HMRC are still trying to fight share splits in husband/wife companies, double-despite the proposed legislation being shelved.

Whilst HMRC lost this case, the judgment fell totally on how much she had invested (half of mortgage) vs. what she received (41.7% of dividends). Therefore this doesn’t actually help in the majority of companies where spousal shares are used to shift income and save tax.

Reading between the lines may reveal that HMRC could have more luck where there is actually no investment from the spouse. This is an area we will keep a close eye on.