The Hindu Business Line : A family tragedy in which the accountant played the villain

GANDHIJI said, "I have a very high opinion of the marriage tie. I hold that husband and wife merge in each other. They are one in two or two in one." This lofty thought seems to influence tax law too, as in the case of clubbing provisions contained in Section 64 of the Income-Tax Act.

In the UK, there's the spouse tax or the couples tax, and it has come under focus after the recent judgment of the High Court in the Arctic Systems case. "Chilling blow for husband and wife business owners," reports www.peterboroughtoday.co.uk, while www.freelanceuk.com cautions, "Taxman stalks business consultants". The taxman's newly adjusted radar dish, as www.money.telegraph.co.uk puts it, can get thousands of H/W firms to pay more tax. Whether the number will be 30,000 or two lakh, nobody is able to guess.

To know more, download the 20-page judgment in Geoffrey Peter Jones vs Michael Vincent Garnett (HM Inspector of Taxes) a.k.a. Jones vs Garnett, where Mr Justice Park narrates the facts. "Mr Jones is a specialist in information technology. Until 1992 he worked as an employee of one or more unrelated companies, but his employment came to an end in that year. He and his wife discussed matters, and decided that he would set up his own business. However, on the advice of accountants he established it in corporate form, and by the use of a company jointly owned by himself and his wife. A company called Arctic Systems Limited was acquired from company formation agents."

The company's capital consisted of only two shares, each of £1, that the husband and wife paid for. On the `advice of accountants', the judgment notes: "The first accountants also advised that it was normal for husbands and wives to own the shares in this way as the entitlement to dividends depended upon the ownership of the shares." Accordingly, Mr Jones understood that, if dividends were paid to his wife, the overall tax payable would be less than it would be if all the dividends were to be paid to him.

"Mr Jones was the sole director. Mrs Jones was the company secretary. Mr Jones did not have a written service agreement with the company, but all his working activities were carried out as a director and employee. The company's business consisted of providing Mr Jones's services to outside users, through agencies, for fees."

What did Mrs Jones do? "Mrs Jones undertook all the book-keeping work, liaised with accountants and the bank, organised business insurance, prepared the value added tax returns and paid the tax; and did the company's invoicing. She signed off the company's accounts in her capacity as company secretary... She worked on average about four or five hours each week on company business."

The two agreed that Arctic would pay them salaries to meet their basic needs and that any profits would be distributed as dividends. "The company received quite large sums for providing Mr Jones's services to third parties; it paid small salaries to Mr and Mrs Jones, thereby leaving itself with a substantial profit. After providing for corporation tax on the profit, it distributed virtually all the balance as dividends."

Which is where the taxman was interested. The Revenue contended that the dividends paid to Mrs Jones were income arising under an `arrangement' of which the settlor was Mr Jones and that the dividends were deemed to be his income under the settlement provisions contained in Section 660A of the Income and Corporation Taxes Act of the UK.

Mr Jones's salaries for the four years of assessment from 1996-97 to 1999-00 ranged from a low of £6,520 (1999-00) to a high of £7,146 (1996-97), while turnover ranged from a low of £78,355 (year to October 31, 2000) to a high of £91,123 (year to October 31, 1999), and Mrs Jones's share of dividends ranged between a low of £23,450 (in 1997-98) and a high of £28,750 (in 1998-99).

The judgment went in favour of the Revenue. However, Mr Justice Park offers a clue about the husband's salary: "It would be far harder for the Revenue to establish that there is a settlement or arrangement of which a husband is a `settlor' if he is paid the going rate for employees carrying out the sort of work which he does."

On what the position in India would be, Mr V. K. Subramani, CA, explains: "If a husband and wife commence a business by forming a company with equal shareholding, dividend distribution will have no impact on them, as the company has to pay tax on dividend distributed as per Section 115-O. The salary of the spouse is also not liable for clubbing if he/she possesses relevant qualification and experience. Where both the husband and wife have 50 per cent stake in the company, as in the Jones's case, clubbing provision (Section 64) cannot operate; this, despite the absence of relevant qualification and experience, as both of them have substantial interest in the company." Something to make many a reader breathe freer!

"A happy home is one in which each spouse grants the possibility that the other may be right, though neither believes it," said Don Fraser.

Ditto with professional relationships, too, between client and auditor, I'd say, with neither believing the other. Perhaps, the tragedy of the Joneses was that the couple thought the `first accountants' were right.

Should a caddie nudge the ball into the hole?

ANOTHER case worth a thorough study is Standard Chartered Bank vs Directorate of Enforcement, decided by the Supreme Court on May 5. It was delivered by a five-judge constitution Bench by a split verdict of 3:2.

The bank argued that no criminal proceedings could be initiated against it for the offence under Section 56(1) of FERA as the minimum punishment prescribed under it was imprisonment for a term which shall not be less than six months and with fine.

"The question that arises for consideration is whether a company or a corporate body could be prosecuted for offences for which the sentence of imprisonment is a mandatory punishment," said the court, and devoted attention to precedents such as the Velliappa Textiles case. In that case, the majority decision was that the company cannot be prosecuted for offences that require imposition of a mandatory term of imprisonment coupled with fine; "it was further held that where punishment provided is imprisonment and fine, the court cannot impose only a fine".

In the current case, the majority view was that there is no blanket immunity for any company from any prosecution for serious offences merely because the prosecution would ultimately entail a sentence of mandatory imprisonment. Corporate bodies, such as a firm or company, undertake series of activities that affect the life, liberty and property of the citizens, said Justice Mr K. G. Balakrishnan, on behalf of himself and Justices Mr Arun Kumar and Mr D. M. Dharmadhikari.

"Large scale financial irregularities are done by various corporations. The corporate vehicle now occupies such a large portion of the industrial, commercial and sociological sectors that amenability of the corporation to a criminal law is essential to have a peaceful society with stable economy." Thus, the majority view in the Velliappa case got overruled.

The dissenting judgment of Justice Mr B. N. Srikrishna and Justice Mr N. Santosh Hegde prefers to tread the conventional path that the maxim `judicis est just dicere, non dare' best expounds the role of the court. "It is to interpret the law, not to make it. The court cannot act as a sympathetic caddie who nudges the ball into the hole because the putt missed the hole. Even a caddie cannot do so without inviting censure and more. If the legislation falls short of the mark, the court could do nothing more than to declare it to be thus, giving its reasons, so that the legislature may take notice and promptly remedy the situation. This is precisely what has happened in the present case."

And: "We are unable to subscribe to the view that by `judicial heroics' it is open to the court to remedy an irretrievable legislative error by resort to the theory of presumed intention of the legislature."

An arresting read!

AccountSpeak@TheHindu.co.in

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