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Mark McLaughlin outlines two unusual tax cases concerning dividends.

Introduction

Recent case law has highlighted two interesting scenarios involving dividend payments.

Recategorised Dividends

In Stirling Investments v HMRC [2010] VKFTT 61 (TC) TCOO374, a VAT Case, a husband and a wife partnership were also director shareholders of a company. The partnership invoiced the company for a management charge of £525,000 plus VAT. However, the company later sought to argue that the management charge was erroneous and that the payment represented dividends. The issue in the case was whether or not a taxable supply had been made by the partnership. HMRC contended that the payment by the company to the partnership was indeed in respect of management charges.

The tribunal concluded, on the facts of the case, that the situation had arisen due to an accounting error by the appellants and their finance director. It held that no taxable supply occurred, and therefore allowed the taxpayer’s appeal.

At first glance, the decision in this case presents some interesting tax planning opportunities. It suggests that transactions can be recategorised with the benefit of hindsight. Unfortunately, this is unlikely to be the situation in most cases. The tribunal pointed out that what occurred was “… a true error as opposed to a situation where a party has intended to characterise a transaction as a supply but is now of the view that it was not the most beneficial interpretation.” The tribunal added: “Clearly it was the intention of all relevant parties…that the £525,000 should be released to the partnership as a dividend and by way of a distribution of profits...” “No substantial management services have been delivered by the partnership to the company…”

However, what this case does illustrate is that it can be possible to amend transactions to their true nature, where there has been a genuine error in the original transaction, with no dishonesty or intent to deceive.

NIC on Dividends

One of the advantages of dividends over salaries or bonuses in remuneration planning has traditionally been that there is normally no NIC on dividends. However, HMRC successfully sought a Class 1 NIC charge on distributions in PA Holdings Ltd v HMRC (and related appeal) [2009] UKFTT 95 (TC) TC00063.

The case broadly involved arrangements to re-route employee bonuses so that they were paid as company dividends and would therefore be taxable as distributions. The stated aim of the arrangement was “to motivate and encourage employees in the performance of their duties.”

The tribunal held that the amounts paid to the employees were both distributions and earnings, but that “Schedule F trumps Schedule E” (in other words, that distribution treatment takes precedence over an employment income charge). However, having found as a fact that the payments were earnings, the tribunal concluded that the payments were liable to Class 1 NIC.

The PA Holdings case was appealed, and the decision has yet to be released at the time of writing. However, it should be noted that the dividends in that case were part of a bonus planning arrangement for the employees and shareholders. It seems unlikely that HMRC would seek to impose a Class 1 NIC charge on dividends on ‘plain vanilla’ shares to shareholders in family or owner-managed companies, where the dividends are properly voted and paid, and the individual already receives adequate remuneration for any duties performed. Of course, a change in the law to impose Class 1 NIC charge in the future cannot be ruled out.

filed.       

The above article is reproduced from Practice Update (May/June 2010), a tax Newsletter produced by Mark McLaughlin Associates Limited. To download current and past copies, visit: Practice Update.