When a dividend is also subject to NICs…

2010 UPDATE: This case subsequently went to appeal - see When a dividend is subject to NICs (Part 2)

This case is going to excite tax advisers because it is often argued that a dividend can only be taxed once – as a dividend, but no one has been particularly clear about the NICs aspect, until now. The decision has important ramifications for small companies who use dividends as part of the remuneration package, as well as for those designing share based incentive schemes.

In PA Holdings Ltd and Kully Janjuah v HMRC [2009] UKFTT 95 (TC) distributions, in the form of dividends, made to the employee beneficiaries of a company’s Employee Trust (ET) were employment income. As they were dividends they could not subject to double taxation, so PAYE did not apply and they were taxed as dividends.The fact that the income was in the form of dividends did not prevent them from being also treated as earnings for National Insurance Contributions (NICs) purposes, and so NICs applied.

Background: employee trusts
An ET is a trust set up by a company which is intended to provide benefits of various descriptions to the company’s employees. These trusts are generally known as EBTs (employee benefit trusts) but they can also be called ESOTs (employee share ownership trusts) if they are share based. The ET falls under the supervision of trustees who are independent of the company and is usually located off-shore (this is so that there are no capital gains issues for trustees). A company will fund an ET by making a contribution of its profits to the ET. The trustees of the ET may then award these funds to the benefit of some of the company’s employees.

Background: the case
PA Holdings Ltd (PA) was an employee owned company and allocated a large proportion of its profits to its employees. It had set up various ETs in the past. In 1999 a new trust was set up. The company paid a capital contribution into the ET, which it used to subscribe to shares in a company called Ellastone. Another company, Juris, was made nominee and legal owner of the shares. The beneficial ownership of the shares was awarded to employees after consideration by the trustees of the ET as part of the reward system of PA’s employee share reward plan. Ellastone paid a dividend on its shares out of the capital contribution it had received from the ET (which in turn had come from PA). The dividend was paid to Juris, who then paid it to the beneficial owners, those employees of PA who had been given share awards, net of 25% withholding tax. It did this for several years until the trust was wound up.

  • HMRC assessed the company for PAYE and NICs on the dividends claiming that they were taxable as employment income.
  • The company appealed claiming that the dividends were dividends and so only subject to income tax.
  • The a case was heard by the First Tier Tribunal of the Tax Chamber, its judges decided that there was more to it than that, perhaps the payments were capable of being two things at once.

The judgment:

Dividends and emoluments
Introducing the point that, ”One of the most important unwritten rules of income tax is that income generally can be taxed only once.” The judges agreed that the provisions of the taxes act are unambiguous, a dividend is taxed as a dividend, as so it cannot therefore by taxed twice by applying PAYE (note that the judgment looked at s20(2) of ICTA 1988, as this is what was relevant to the years under review, this is now rewritten (to the same effect) in s366 of ITTOIA 2005).

The point of law: the fact that a dividend can also be treated as employment income for tax purposes does not mean that it can also be subject to tax under PAYE. S415 ITTOIA 2005 trumps s62 ITEPA 2003.

Dividends and earnings for NICS
Earnings for NICs includes any remuneration or profit derived from employment. So the judges found that the dividends did derive from the employees’ employment with PA. They were paid out as part of an employee reward system after all, and there is nothing in the NICs legislation which prevents a dividend from being earnings too. The dividends were therefore subject to NICs.

The point of law: there is nothing in the taxes act which says that a dividend should not be classed as earnings for NICs: nothing trumps NICs.

The company may appeal, we must wait and see. Further analysis is on its way.