KembaraXtra - Legal Terms - Settlement Code

The Settlement Code is a group of statutory anti-avoidance provisions, now contained in sections 619–648 of the Income Tax (Trading and Other Income) Act 2005 (ITTOIA 2005), designed to prevent taxpayers from reducing their income tax liability by transferring income-producing assets while retaining the economic benefit of the underlying property. Where the Code applies, the income is treated for tax purposes as belonging to the settlor (donor) rather than the recipient.

The legislation primarily targets two common situations. The first involves gifts of income-producing assets from parents to minor children, preventing parents from diverting taxable income into the child’s lower tax bracket. The second concerns arrangements where income is transferred to another person while the settlor retains, or may later regain, the capital or other economic benefits arising from the property.

The Settlement Code serves three principal objectives:

1. Preventing trusts from acting as tax shelters, where income is taxed at lower rates before ultimately benefiting the settlor.
2. Restricting income splitting within families, particularly between parents and minor children, to obtain lower tax rates.
3. Preventing artificial separation of income from capital, where income is assigned to a lower-rate taxpayer while ownership of the underlying asset effectively remains with the original owner.

A leading authority is Jones v Garnett (2007), commonly known as the Arctic Systems case. Mr Jones operated a company providing computer consultancy services, while his wife owned ordinary shares in the company and received dividends. Although a majority of the House of Lords accepted that the share arrangement constituted a settlement, the Court unanimously held that a statutory exemption applied because the wife received an outright gift of ordinary shares carrying genuine ownership rights. Accordingly, the dividends were taxable as the wife’s income rather than as the husband’s.

The Settlement Code represents an important part of the United Kingdom’s anti-tax-avoidance legislation. It ensures that taxation reflects the true economic ownership and enjoyment of income rather than artificial legal arrangements designed solely to reduce tax liabilities.