PA Holdings v HMRC: the Court of Appeal decided that when a bonus is structured as dividends it can be taxed as employment earnings for both PAYE and NICs. The company withdrew its appeal to the Supreme Court on 11 April 2013.
PA Holdings Limited paid its staff bonuses annually. In 1999 it set up a discretionary employee bonus scheme designed to provide it with 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 benefit trust (EBT) 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” - i.e. 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. 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.
Following the Court of Appeal judgment many hoped for an appeal to the Supreme Court, but the taxpayers dropped their appeal in 2013.
The ICAEW had even written to the Supreme Court in February 2012 supporting the appeal on the following grounds:
“Whereas this is an anti-avoidance case it does not appear to have been decided on a basis of law specific to arrangements entered into for tax avoidance. Our concern is that the judgment of the Court of Appeal has thrown into doubt many common arrangements, which include the way dividends received by director-shareholders are to be treated for tax purposes even in the most straightforward of cases. Under self-assessment this also creates uncertainty as to the correct form to use to make a return of such income. We are also aware that the Government is keen to promote share ownership for employees. The tax uncertainty that is created by the Court of Appeal judgment will serve to undermine this public policy objective.”
HMRC has been reasonably successful in tackling PAYE and NICs avoidance schemes over the years. It continues to be suspicious of "thin shares", as in shares with no rights other than to a dividend and any arrangement where bonus payment is made to an employee via a series of different steps involving other companies, EBTs and changes of rights. Whilst there is no block to an employer awarding whatever variety of shares that it likes to employees, clearly an award of ordinary shares which give then an actual share of the business rather than a mere right to some income is unlikely to be regarded as tax avoidance unless part of a greater contrived arrangement.
Tax schemes which seek to substitute dividends for annual salary bonuses will attract HMRC's attention, however where employees are awarded shares under approved schemes such as the government's new employee share ownership plan it would be contrary to employee shareholder participation if dividends paid on those shares attracted PAYE or NICs, see commentary, NICs on dividends.
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