Contractors Dividends Should be Safe

No appeal by PA Holdings

In November 2011, the Court of Appeal found in favour of the Revenue in the case of HMRC v PA Holdings, overturning 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 1990s, management consultancy, PA Holdings paid its employees millions in bonuses by way of dividends via a complex arrangement that involved employee benefit trusts and a series of different share classes. As freelancers know, paying dividends not only saves Employees/Employers NIC's but also reduce an employee’s tax burden. Unsurprisingly, 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.

PA Holdings have now decided not to appeal the Court of Appeal decision to the Supreme Court and HMRC have confirmed 'The judgment in the Court of Appeal is now final. HMRC will be contacting those whose appeals remain open or are stayed pending the outcome of this case.' The Revenue has intimated that a significant number, possibly in the hundreds, of very similar cases will be affected by PA Holdings conceding.

At the time of the Court of Appeal decision, ministers gave assurances that genuine dividends would not challenged by HMRC and the Revenue seem to be giving out the same signals following this recent development.

It must be remembered that PA Holdings concocted a contrived scheme and sought a corporation tax deduction as well as wanting dividend treatment. This is not something contractors would be likely to set up for their own businesses. However, some freelancers may have established alphabet share schemes for their companies and these could come under closer scrutiny from HMRC.

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