HMRC sought PAYE on ‘re-classified’ dividends
A husband and wife who ran Perfect Change Ltd, a recruitment company, were told by a First Tier Tax Tribunal that they will not have to pay PAYE tax and NIC on dividend income that HMRC sought to argue was really salary.
Richard and Julie Jones formed their company in July 2003 to recruit primarily in the banking and financial services sector. In the summer of 2008 however the company began to feel the effects of the global financial crisis and finally became insolvent, going into liquidation in February 2009.
Shareholdings were held 65:35 in favour of the husband and the majority of their income from the company was by way of dividends, although they did receive a modest monthly salary.
Monthly management accounts were prepared to enable Mr and Mrs Jones to set the level of appropriate dividend. The annual accounts for the year ended 31st March 2007 showed directors’ salaries of £10,800 and dividends of £139,000. The first set of draft accounts for the year ended 31st March 2008, which had been produced by 9th May 2008, showed directors’ salaries of £10,800 and an interim dividend of £138,100.
In the latter half of 2008, the Jones’s reduced the level of dividend by 50% and between August – December 2008 had received dividends of £22,000. Contrast this with the same period in the previous year when the couple had received dividends of nearly £57,000.
In January 2009 Mr and Mrs Jones held a meeting with their accountant who advised them to consult an insolvency practitioner with a view to placing the company into liquidation. The accountant also pointed out that there was an overdrawn directors’ loan account which the liquidator would seek repayment. As such, it appears that the accountant may have considered that there was a risk that the liquidator might treat the dividends as unlawful. To avoid this therefore, the accountant advised that the dividends be reclassified as salary but neither client nor advisor had appreciated that HMRC might seek to recover subsequent PAYE and NIC from Mr and Mrs Jones personally.
Following the company’s liquidation, HMRC launched an investigation into whether there had been a wilful failure to deduct PAYE tax and NIC from the dividends that were reclassified as salaries, in 2007/08 and 2008/09. The Revenue concluded there had and that Mr and Mrs Jones knew of that failure. The taxpayers denied this and maintained that the dividends were only ever that and therefore there was no obligation to operate PAYE and NIC.
HMRC argued that the point at which the dividends were reclassified as salary was the relevant time when PAYE and NIC should have been deducted. However, the Tribunal did not consider the interim dividends to be unlawful and at no point did HMRC ever suggest they were either.
The presiding judge said, “It seems to us that the reclassification which occurred in the present case did not truly reflect the nature of the payments at the time they were made. The directors cannot retrospectively alter the nature of the payments simply by deciding to treat them differently. The payments were clearly made as interim dividends and taxable as such rather than as salary.”
The Tribunal concluded that there was no obligation on the company to deduct PAYE tax and NIC, either at the time of payment or at the time of reclassification and therefore found in favour of Mr and Mrs Jones.
I might be being a bit naive here, but isn’t it obvious that HMRC would be after PAYE and NICS under these circumstances?