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Busy Practitioner by Mark McLaughlin CTA (Fellow) ATT TEP

Mark McLaughlin CTA (Fellow) ATT TEP, Editor of TaxationWeb Ltd, outlines some topical practice points concerning dividends as employment income and company purchases of own shares.

Dividends as employment income

Changes to the employment income rules on shares and securities introduced in F(No.2)A 2005 contain an unpleasant surprise for some employee shareholders (and possibly practitioners too!). The legislation effectively provides not only for National Insurance contributions (NIC) on dividend income, but also for a potential double charge to income tax on the same income.

The rules on post-acquisition benefits from securities (ITEPA 2003, Part 7 Chapter 4) are widely drawn, and affect the receipt of a ‘benefit’ (including dividends) from employment-related securities. Prior to the F(No. 2)A 2005 changes, the relevant charging provision (ITEPA 2003, s 447) did not apply if a benefit was otherwise chargeable to income tax. However, s 447 can now still apply if ‘…something has been done which affects the employment-related securities as part of a scheme or arrangement the main purpose (or one of the main purposes) of which is the avoidance of tax or National Insurance contributions’ since 2 December 2004.

ITEPA 2003, s 449 excludes employment-related securities from the benefits charge if certain conditions are satisfied. However, this exclusion no longer applies if something affecting the shares or securities is done with an underlying tax or NIC avoidance motive.

It is unclear from the amended legislation (or from the Explanatory Notes introducing the changes) what type of actions must be ‘done’ for the provisions to bite. Some comfort can perhaps be drawn from statements by Revenue & Customs in the Explanatory Notes, that the F(No. 2)A 2005 changes affecting employment-related securities were mainly introduced to counter schemes ‘…to pass remuneration value to employees in a way that attempts to avoid or reduce income tax and NICs.’ The arrangements that Revenue & Customs presumably have in mind include the issue of ‘alphabet’ shares to employees with restricted rights apart from entitlement to dividends, where those dividends can be paid to employees at different rates by virtue of their separate classes of shares.

However, the position regarding dividends on shares with ‘full’ rights where different rates are paid on separate classes of share is less clear. In addition, it seems possible that arrangements involving shares or securities caught by the ‘settlements’ anti-avoidance rules (ITTOIA 2005, s 624, formerly TA 1988, s 660A) could be caught by the benefits rules. At the time of writing, Revenue & Customs have not provided clarification on the scope of situations affected by the recent amendments to the legislation. One hopes that they will do so very soon.

Purchase of own shares

In Allum and another v Marsh (Inspector of Taxes) [2005] STC (SCD) 191, the Special Commissioner considered, among other things, the ‘trade benefit test’ (TA 1988, s 219(1)(a)), which is a condition for capital gains treatment to apply on the purchase by an unquoted trading company of its own shares. In that case, the taxpayers’ appeal was dismissed and the share buy-back payments amounted to a distribution by the company. The Special Commissioner concluded that the purchase of the shares was not made wholly or mainly to benefit the trade, but to facilitate the taxpayers’ retirement.

The difference between an effective 10% capital gains tax rate (with maximum business asset taper relief) on a capital distribution and 25% tax on an income distribution for a higher rate taxpayer often makes the conditions for capital treatment crucial. The purchase of own shares provisions (TA 1988, ss 219-229) therefore merits careful consideration. Fortunately, most of the conditions (e.g. as to the taxpayer’s residence, or period of share ownership) are unambiguous. However, the trade benefit requirement is not defined in the legislation, and is subject to guidance in Statement of Practice 2/82. This Statement cites examples of situations in which the trade benefit test would normally be regarded as satisfied, including the purchase of shares from a controlling shareholder who is retiring as a director and wishes to make way for new management. However, even if the circumstances fit within the examples in Statement of Practice 2/82, the Allum case underlines the requirement that the purpose of the share buyback must be to wholly or mainly benefit the company’s trade, not the company or the shareholder.

It should be remembered that Statements of Practice represent the views of Revenue & Customs, and are not legally binding. Nevertheless, practitioners should be aware of Statement of Practice 2/82 and its contents, including the suggested order of advance clearance applications on a purchase of own shares (TA 1988, s 225). This contains a statement of the expected ‘purpose and benefits’ of the purchase, trading and otherwise. A comprehensive explanation why the trade benefit test (and other conditions) is considered to be satisfied will at least provide certainty on what is otherwise a potential ‘grey area’, as illustrated by the Allum case.

August 2005

Mark McLaughlin CTA (Fellow) ATT TEP

The above article was first published in ‘Busy Practitioner’ in August 2005.