Future Risk to Dividends?

Last November, the Court of Appeal found in favour of the Revenue in the case of HMRC v PA Holdings. The decision overturned the ruling in the Upper Tier Tax Tribunal that dividends paid to employees through a restricted share plan were both dividends and earnings.

In the 1990's, management consultancy, PA Holdings paid its employees millions of pounds in bonuses by way of dividends via a complex arrangement that involved employee benefit trusts.

As our readers are well aware, paying dividends would not only save Employees/Employers NICs but also reduce an employee’s tax burden. Not surprisingly, HMRC took exception to the scheme and argued that the dividends were earnings and should be taxed at normal rates and be subjected to Class 1 NICs.

In finding in favour of HMRC, the Court of Appeal said that the Upper Tier Tax Tribunal had erred in concluding that the employment income and dividend taxation rules could both be relevant. Lord Justice Moses stated that income falls to be taxed under one set of rules only. The fact that the income fell within Schedule E (employment income) precluded any finding that the income could also fall within Schedule F (dividends). This was a divergence from historical tax treatment as income that could be described as both dividends and bonuses was treated as dividends for tax purposes.

Although it is not yet known whether or not PA Holdings will be permitted to progress an appeal to the Supreme Court, if it does and loses and HMRC decide to attack all dividends paid to employee shareholders then this would have far reaching repercussions. Ministers have, however, given assurances that genuine dividends will be acceptable.