Tax scheme fails to take advantage of the settlements rules

In Sharon Clipperton & Steven Lloyd v HMRC UKUT 00351, the Upper Tribunal (UT) agreed that a dividend tax avoidance scheme relying on the automatic application of the Settlement provisions did not work. The individuals, and not their company were the settlors of the arrangement.

The appellants were the sole shareholders and directors of Winn & Co (Yorkshire) Ltd (WY) who participated in a ‘dividend replacement strategy’ scheme known as 'Aikido' which sought to use the anti-avoidance Settlements provisions to the advantage of the appellants:

• WY formed a new subsidiary Winn Scarborough Ltd (WS) by subscribing for 199 A shares, one B share and one additional A share with a £200,000 premium.
• The B share was settled on trust mainly for the benefit of the appellants with a small amount of income retained by WY.
• The additional A share was cancelled. This left distributable funds which were used by WS to declare a dividend on the B share. The trust allocated a small amount of this to WY and a charity and the rest to the appellants.
• The appellants treated the dividend income as taxable solely upon WY as settlor, as required by the automatic operation of the Settlement rules in s.624 ITTOIA 2005, and therefore as non-taxable as a dividend paid between UK close companies. 
• HMRC argued that the appellants were taxable on the B share dividend, either under the Ramsay principle or because they were actually the settlors, not WY.

On appeal against HMRC's assessments, the First Tier Tribunal (FTT) found that the payment was a distribution taxable on the appellants:

• The trust was structured so as to ensure that WY retained sufficient income as to be taxable under the Settlements legislation.
• WY’s only purpose in paying the premium of £200,000 for an A share was to fund the B share dividend.
• Each step had legal and commercial effects but that did not prevent the tribunal taking a broad view of the effect of the transactions applying Ramsay,
• The appellants had contributed indirectly to the arrangement, however, they were not the settlors of the arrangement as there was no element of bounty.
• The appellants appealed the distributions points and HMRC cross-appealed the Settlements rules.

The Upper Tribunal considered the Ramsay issue on and found that:

• The FTT had carried out a thorough and careful analysis of the relevant authorities and reached the right result in terms of a purposive construction of the relevant distribution provisions.
• WY (and not WS) had made a distribution out of assets in respect of shares to the Appellants, and this was taxable on them as a distribution.
  • WYs assets were depleted to the tune of £200,000 and a corresponding sum was put into the hands of its shareholders (less the small sums paid to WY and the charity) with the specific purpose of providing the shareholders with a return on their shares.
  • The fact that the appellants did not receive the sums directly from WY but through a series of steps designed solely with the intention that they would not be subject to Income Tax on the sums did not detract from the nature of the receipt in their hands.

Both parties had also appealed elements of the Settlements issue.

The appellants argued that the Settlement code was 'prescriptive' and 'took priority' over any other legislation: therefore the £200k distribution was income arising from a Settlement. 

• The UT brushed this aside on the basis that the dividend on the B share was not the same as the distribution in respect of shares by WY.
• Once the FTT had correctly found that under the distribution code there was a distribution in respect of shares by WY, "that distribution could not be conjured away by the applicability of the Settlements code to a different distribution". 

The UT said that is was not strictly necessary to consider the further Settlement arguments, as it had by this stage, decided the appeal HMRC's favour. It did go on to consider whether the FTT had been correct in making a conclusion that the appellants were not settlors because they had not provided any 'element of bounty' to the arrangement.

Intriguingly, the UT did not consider that any of the authorities directly addresses the question of whether it is possible for a person to be a settlor without themselves providing an element of bounty.

• It agreed that the general effect of the case authorities is that the element of bounty test means that the settlor must provide a benefit which would not have been provided in a transaction at arm’s length.
• It noted that such a test is not on all fours with a test which turns on whether a settlor who indirectly provides property for the purposes of the settlement has a hope and expectation of receiving back as income from the settlement an amount equivalent to a large percentage of the trust property (the B share), with another beneficiary being entitled to the trust property itself.

It found that the FTT misdirected itself in several respects in relation to the legal test imposed in case law by the element of bounty requirement, and in that event, its finding of fact was vitiated by those errors of law. The FTT had erred in law in concluding that the Appellants did not provide the necessary element of bounty to the Settlement in this case.

The appellants' alternative argument was that the effect of the rules of Settlement was that the trust income could be apportioned to the appellants.

• The UT confirmed that the appellants had indirectly provided property to the Settlement as they had approved the arrangements under the scheme as directors of the companies, in doing so they were indirect settlors for the purposes of s.644- 645 ITTOIA 2005.
• As the appellants could be indirect settlors, the effect of the provisions would be that they could be taxed on the dividend accordingly.

HMRC’s cross-appeal was also allowed.

Useful guides on this topic

Settlement income scheme a distribution under Ramsay (subscriber guide)
In Sharon Clipperton & Steven Lloyd v HMRC [2021] TC07998, the First Tier Tribunal (FTT) found that a profit extraction scheme that aimed to trigger the Settlements legislation was really just a distribution to the settlor's shareholders. 

Settlement anti-avoidance rules
What are the settlement anti-avoidance rules? How do these rules catch some common family tax planning? What are the rules for spouses and other family members?

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Sharon Clipperton & Steven Lloyd v HMRC UKUT 00351