TSEM4205 - Settlements legislation: exceptions to the statutory definition of settlement

ITTOIA/S626

The term ‘Settlement’ does not include an outright gift by one spouse to another unless

• the gift does not carry a right to the whole of the income or
• the property given is wholly or substantially a right to income.

Example4 – outright gift

X owns a property that is let at a commercial rent to an unconnected third party. X transfers the property by outright gift to his spouse Y who then receives the rents. X has no further interest in or rights over the property. The rents that Y receives are not subject to the Settlements legislation. They are Y’s income for tax purposes.

Example 5 – outright gift wholly or substantially a right to income

An engineering company has 100 ordinary £1 shares. Mr P and Mr O own 50 ordinary shares each. They create a new class of B shares which carry no voting rights and no assets in a winding up. They then issue 50 B shares to each of their wives. Dividends voted on those B shares would be treated as the income of Mr P and Mr O rather than their wives as the B dividends are from shares that are wholly or substantially a right to income and so not exempted from section 624 by section 626. (This example is based on the High Court case of ‘Young v Pearce; Young v Scrutton (1996) STC 743’).

Example 6 outright gift not wholly or substantially a right to income

X is an IT consultant. He owns all the shares in a private company through which he sells his services. The company receives all the income he generates. The company’s only source of income is from work carried out by X. It has insignificant capital assets. X transfers his shares in the company to his wife by way of gift. His work in one year earns the company more than £70,000 but he decides to draw only £40,000 salary. This leaves £30,000 profit for the company. The company then pays a dividend of £30,000 to Mrs X. The arrangement effectively transfers part of X’s earnings to his wife. However, the House of Lords judgement in the case of Jones v Garnett confirmed that the focus of ITTOIA/S626 was the settled property. Regardless of the underlying arrangement the transfer of shares is an outright gift between spouses. Unlike the shares in example 5 above, the property gifted here is a holding of ordinary shares with rights to capital. The gift is not therefore of property which is wholly or substantially a right to income. The Settlements legislation does not apply and we would not treat the dividend as the income of X.