PA Holdings withdraw appeal- are dividends secure?
HMRC announced on 11 April that PA Holdings Limited had withdrawn its appeal against the Court of Appeal judgement in PA Holdings v Revenue and Customs Commissioners  – the case in which payments in the form of dividends, as part of a tax and NIC avoidance scheme, were held to be emoluments chargeable to PAYE and NICs.
The withdrawal of the appeal means that this judgement is now final and speculation once again arises as to the impact of the ruling on other situations where dividends are paid to employees and office holders – particularly where separate classes of shares are held. The case is therefore an important one for practitioners advising companies and their shareholders on remuneration planning and general profit extraction.
Outline of the case
In 1999, PA Holdings Limited (“PHL”) decided to re-route cash bonuses so that they were paid as dividends from a UK resident company via a new employee benefit trust (“EBT”). The aim was to achieve both a corporation tax deduction on the payments made to the EBT and for employees to receive distributions which would avoid NIC and benefit from lower rates of tax.
The arrangements were complex and involved offshore companies. One such company was established merely to award shares to employees in order to facilitate the payment of dividends, which were funded from a capital contribution made to the company from the new EBT, which itself was funded by PHL.
HMRC took the view that the dividends were emoluments from employment and therefore subject to PAYE. PHL contended that the payments were made to the individuals derived from the ownership of shares and were therefore dividends. Both the First-tier and Upper tribunals found that although the payments were emoluments they were also dividends. Legislation (s20 ICTA 1988 now replaced by s716A ITEPA 2003) confirmed that where a payment was taxed as a dividend this took priority and the payment could therefore not be taxed as an emolument. They also found that the rules for NIC were different and that the payments were earnings for NIC purposes.
Court of Appeal decision
L J Moses and LJ Arden took the view that the tribunals had both erred in deciding that the payments could be both chargeable as emoluments and as dividends. They held that income falls under either one or the other and that where it is an emolument from employment, this precludes it from being taxed as a dividend.
LJ Moses added that the award of shares and the declaration of the dividends were in reality not separate steps but the process for the delivery of the bonus.
The payments were therefore chargeable to tax and NIC under PAYE.
Impact for smaller companies and their shareholders
The on-going concern about this decision is that it will provide HMRC with grounds to challenge any arrangement where director shareholders are able to take dividends instead of bonuses. While those case on all fours with PHL will be clearly in the firing line, it is worth putting this decision into perspective when considering the wider implications for owner managed companies and their shareholders.
PHL was a large business that set up a complex arrangement involving companies which did nothing but award separate classes of shares to facilitate bonus payments in the form of dividends. The circumstances of the case will therefore be some way off those found in smaller company arrangements which would not typically enter into such sophisticated arrangements.
Thus, in our view, this decision is unlikely to lead to HMRC attacking regular dividends which are paid to bona fide business owners/shareholders as part of the return on their investment in the business. Those who are also taking reasonable salaries in addition to dividends will be at even lower risk.
Having said this, where arrangements are more contrived, for example involving the issue of alphabet shares which provide a right to income to employees in the form of dividends and little else, these will remain high risk and HMRC will no doubt feel more confident about challenging them.
The facts of each case will need to be considered, but where there is a clear motive to enter into an arrangement aimed at avoiding NIC and reducing tax, the broad implications of this case and the post-acquisition benefit provisions of Chapter 4 Part 7 ITEPA 2003 and IR35 will, in future, always need to be considered.