UPDATE: Dec 2011 HMRC successfully appealed to the Court of Appeal on the PAYE point - see When a dividend is subject to NICs (Part 3)

The Upper Tax Tribunal has confirmed that dividends paid to a company’s employees under a discretionary bonus scheme involving a third party company were subject to NICs.

The decision

In PA Holdings Limited set up a discretionary employee bonus scheme. Under the arrangement the company transferred funds into an employment trust which then purchased shares in another company, and in a series of steps shares in the third company were then awarded to employees.

The shares awarded were “thin” according to HMRC’s counsel, in that they carried rights to a single dividend and no voting rights. 

HMRC challenged PA Holdings on the tax and NICs treatment of the income from these third part dividends in the employees’ hands. 

The First Tier Tribunal judge declared that ”One of the most important unwritten rules* of income tax is that income generally can be taxed only once.” And held that:  

  • The payments were to be treated as employment income.
  • The payments also constituted dividends or distributions.
  • The payments were accordingly not chargeable to PAYE.
  • The payments were earnings that were subject to liability for Class 1 National Insurance

HMRC appealed seeking to 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 and so the First Tier’s decision prevails.

There is a summary of the Ramsay principle from the written decision in this case in the next tab.

Case: Revenue and Customs v PA Holdings Ltd [2010] UKUT 251 (TCC)

* Comment from Matthew Hutton: although the judge is quoted as saying that ‘One of the most important unwritten rules of Income Tax is that income generally can be taxed only once’, there is of course a specific tax rule that where income can constitute both employment and dividend income then, as was ruled here, the dividend analysis prevails: ITEPA 2003 s716A and ITTOIA 2005 s366(3).