S.660: Dividend Waivers Were a Settlement

Tax tribunal rules dividend waivers caught by Settlements Legislation

Just when you thought the Settlements Legislation, commonly referred to as S.660, lies dormant it erupts from time-to-time to remind us that it is still relevant.

A recent First Tier Tax Tribunal ruling in the case of Donovan & McLaren v HMRC cost two company directors an additional £27,500 tax for the three years ended 5th April 2010, as a result of them regularly waiving dividends so that their wives could received inflated dividends.

Messrs Donovan and McLaren had been directors and equal shareholders of Victory Fire Ltd since 1992. In 2001 their wives became shareholders at which point the holdings became:

In the company’s accounting period to 31st March 2010 a total of £130,000 in dividends were paid as follows:

In April 2009 two interim dividends were declared in respect of the accounting period 31st March 2010 as follows:

6th April 2009

Dividend:  £3,200 per share.
Dividend waived by:  Mr P Donovan and Mr P McLaren
Dividends paid to wives:  £32,000 each

8th April 2009

Dividend:  £825 per share
Dividend waived by:  Mesdames R Donovan and A McLaren
Dividends paid to husbands:  £33,000 each

Both wives were basic rate taxpayers only.

On reviewing the company’s accounts and the tax returns for the earlier years HMRC produced the following dividend comparisons:

* Above figures replicated from Tribunal manuscript.

Case for the Revenue

HMRC argued that the effect of the dividend waivers, and the intention behind them, was to allow higher dividends to be paid to the wives than their shareholdings permitted and lower dividends to be distributed to the husbands. Both husbands had waived their entitlement to dividends as part of a plan that income otherwise due to them would be paid to their spouses, which constituted an arrangement for the purposes of the Settlements Legislation.

According to the Revenue, it was more likely than not that this plan was implemented with an intention to avoid tax, i.e. that by seeking to bring about a near equalisation of their dividend income, their aggregate tax liability was reduced by taking advantage of the wives’ unused basic rate tax bands.

Without the dividend waivers the company had insufficient distributable reserves to pay the dividends which was supported by a document that HMRC had prepared from the company accounts. This document demonstrated the position with and without dividend waivers and confirmed that had the waivers not been executed in the tax years from 5th April 2001 – 5th April 2010 there would have been insufficient distributable profits to pay a dividend in respect of each share at the rate the wives were paid for each accounting period from 31st March 2002 onwards.

Case for the defence

Mr Donovan and Mr McLaren rejected HMRC’s contention that their company did not have sufficient distributable reserves and produced a document showing the reserves and cash balances from 2000 – 2013.

It had been a commercial decision to waive dividends so as to ensure that the company maintained workable reserves and cash balances in order to accumulate sufficient of each to fund the purchase of the company’s own freehold property.

The Tribunal however found the “irresistible inference” from the facts that the husbands had waived their dividend entitlements as part of a tax saving plan. On the balance of probabilities the Tribunal preferred HMRC’s contention that the aim to fund the purchase of the freehold property could have been achieved by voting a lower dividend per share rather than a succession of dividend waivers and therefore there was no commercial purpose for the waivers.

This case highlights the precautions that companies need to take when implementing dividend waivers and they should be mindful of the factors that HMRC will scrutinize in these cases, which are set out in their manuals:

• The level of retained profits, including the retained profits of subsidiary companies, is insufficient to allow the same rate of dividend to be paid on all issued share capital.
• Although there are sufficient retained profits to pay the same rate of dividend per share for the year in question, there has been a succession of waivers over several years where the total dividends payable in the absence of the waivers exceed accumulated realised profits.
• There is any other evidence, which suggests that the same rate would not have been paid on all the issued shares in the absence of the waiver.
• The non-waiving shareholders are persons whom the waiving shareholder can reasonably be regarded as wishing to benefit by the waiver.
• The non-waiving shareholder would pay less tax on the dividend than the waiving shareholder.