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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:  

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).

The Ramsay Principle

Not sure what is meant by the Ramsay principle? Here is a summary from HMRC v PA Holdings)

27.The progeny of the landmark decision of the House of Lords in WT Ramsay Ltd v IRC [1982] AC 300, (1981) 54 TC 101, has been a series of decisions by the House of Lords and Privy Council, each drawing on its predecessors and developing what is by now a clear line of authority. The decisions are further and fully analysed in the recent judgment of Arden LJ (with whom Keene and Sullivan LJJ agreed) in Astall v HMRC [2009] EWCA Civ 1010, [2010] STC 137. We see little benefit in lengthening this judgment by quoting extensive passages from these various decisions and we think that the principles which they establish can be set out as a series of propositions:

i) The jurisprudence following Ramsay did not introduce a special doctrine peculiar to tax law. It represents the application in the tax field of established principles of broad, purposive statutory interpretation, rejecting formalism in fiscal matters: IRC v McGuckian [1997] 1 WLR 991, per Lord Steyn at 1000, Lord Cooke at 1005.

ii) The approach involves giving the statutory provision a purposive construction in order to determine the nature of the transaction to which it was intended to apply and then determining whether the actual transaction (which might involve considering the overall effect of a number of elements together) answers the statutory description: Barclays Mercantile Business Financial Ltd v Mawson [2004] UKHL 51, [2005] 1 AC 684, (2004) 76 TC 446, per Lord Nicholls at [32].

iii) Revenue statutes are in general concerned with the characterisation of the entirety of transactions which have a commercial unity rather than individual steps into which such transactions may be divided: Carreras Group Ltd v Stamp Commissioner [2004] UKPC 16, [2004] STC 1377, per Lord Hoffmann at [8].

iv) Composite transactions do not cease to have a commercial unity only because they contain a commercially irrelevant contingency, deliberately included to create an acceptable risk that the scheme might not work as planned: IRC v Scottish Provident Institution [2004] UKHL 52, (2004) 76 TC 538, per Lord Nicholls at [23].

v) The approach is not limited to a composite transaction. It can apply to -�a single multi-faceted transaction which on its face operated in a particular way but which when examined against the facts of the case does not operate as a transaction to which the statute was intended to apply-�: Astall, per Arden LJ at [42].

vi) However, whether the statutory provision under consideration is concerned with a single step or a broader view of the acts of the parties depends upon the construction of the language in its context: MacNiven v Westmoreland Investments Ltd [2001] UKHL 6, [2003] 1 AC 311. Hence, -�the purpose must be discernable from the statute: the Court must not infer one without a proper foundation for doing so-�: Astall per Arden LJ at [44].

vii) Accordingly, the mere fact that a transaction is designed for no commercial purpose other than obtaining a tax advantage is not in itself sufficient ground to interpret the application of the statute to the transaction, or an element within it, so as to deny that advantage: MacNiven.

28. Counsel for PA submitted that there is less scope for application of this approach to the charging provisions in the ICTA as they have an established interpretation that already reflects a purposive approach. We reject that submission. Since the Ramsay line of authority establishes general principles of construction in the tax field, we consider that they apply as much to the interpretation of the charging provisions as to any other statutory provisions. Indeed, it would be both artificial and inappropriate to exclude them. It may be that some of the earlier authorities foreshadowed what can conveniently be described as the Ramsay approach, but that does not render that approach inapplicable

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