The Court of Appeal has decided that dividends can be taxed as employment earnings for both PAYE and NICs.
PA Holdings Limited paid its staff bonuses annually. In 1999 it set up a discretionary employee bonus scheme designed to give a corporation tax deduction but make payments to employees via dividends in order to avoid NICs and attract a lower rate of tax.
Having transferred funds into an employee trust the trust purchased shares in another company, by a series of steps shares another offshore company were awarded to employees. The employees received their bonuses as dividends and redeemable shares.
HMRC challenged PA Holdings on the tax and NICs treatment of this income paid to its employees. It also observed that the shares awarded were “thin” - they carried rights to a single dividend and no voting rights.
The First Tier Tribunal found that PA wished to benefit the individuals as employees rather than shareholders. If it had wished to benefit them as shareholders it could have given its own shares (although the plan was to obtain a corporation tax deduction so that precluded that).
The First Tier Tribunal agreed with earlier cases: ”One of the most important unwritten rules of income tax is that income generally can be taxed only once.” It held that:
- The payments were to be treated as employment income.
- The payments constituted dividends.
- The payments were therefore taxable as dividends accordingly they could not also be chargeable to PAYE.
- The payments were earnings that were subject to liability for Class 1 National Insurance
HMRC appealed, seeking to also apply the Ramsay principle in order to unpick the scheme and apply PAYE. The taxpayer appealed on the grounds that the payments were not earnings and so not subject to NICS.
The Upper Tribunal threw out both arguments. HMRC went to the Court of Appeal.
The Court of Appeal looked at the character of the payments:
- PA Holdings had decided to award its employees bonuses.
- The employees received bonuses, albeit in dividend form.
- The fact that bonuses were paid as dividends did not change income accessible as earnings into dividend income.
- In any event be unpicked under the Ramsay principle.
What now?
Those who have read the Court of Appeal judgment may be hoping that there will be an appeal to the Supreme Court. The decision was a bit like a merry-go-round ride - it leaves you feeling a bit giddy and you wonder about the benefit of the experience.
The legislation permitting a corporation tax deduction has changed so the PA scheme is no longer effective. Following the tax re-write project the present tax rules could possibly, dare we say probably give you a different result - this is what without doubt vexed the First and Upper Tax Tribunals. When income can constitute both employment and dividend income then, ITTOIA 2005 dictates that dividend analysis prevails: see ITEPA 2003 s716A and ITTOIA 2005 s366(3). However, if you look at an arrangement like PA's and then apply the Ramsey principle and unpick the steps you may find that you have earnings after all.
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