In Revenue and Customs v PA Holdings Ltd  UKUT B8, the Upper-tier tribunal (UTT) dealt with appeals from both parties against decisions of the First- tier tribunal (FTT).
The case concerned an arrangement by PA Holdings Ltd (PA) to effectively reroute bonuses awarded to UK resident employees, so that they were paid and taxed as dividends rather than employment income. The arrangement broadly involved the payment of funds by PA to an employee benefit trust (EBT) which were subsequently transferred to a newly formed company. Shares in that company were awarded on behalf of PA employees, on which dividends were subsequently paid. The stated purpose of the arrangement was to ‘motivate and encourage employees’.
The FTT held that the payments to the employees were employment income. It also held that the payments were distributions, which meant that the payments had to be taxed like dividends, in priority to employment income treatment, as provided by the relevant legislation. For National Insurance purposes, there is no legislation addressing payments of a dual nature (i.e. employment income and dividends), and the FTT therefore held that the payments attracted liability for Class 1 contributions applicable to earnings.
The UTT upheld the decisions of the FTT, and dismissed the appeals. On the National Insurance issue, it was held that the conclusion of the FTT was ‘clearly correct’. This would appear to rule out the possibility of a further appeal on this point, in which case we are stuck with the principle that dividends can potentially be liable to employees and employers NIC.
Of course, the dividends in the PA Holdings case were part of the relatively complex arrangement to reward employees. It remains to be seen whether HMRC will use the decision to challenge more straightforward remuneration planning, e.g. including low salary and high dividends. It is possible that HMRC will adopt a similar policy as for employment related securities purposes in respect of ‘post-acquisition benefits’ from shares. In other words, dividends paid in respect of ‘plain vanilla’ ordinary shares would not be challenged. On the other hand, dividends in respect of ‘alphabet shares’ (e.g. ‘a’ ‘b’ ‘c’ class shares) awarded to employees may be at risk, particularly if those individuals are not already receiving remuneration at a commercial rate.
The Ramsay Principle
An interesting postscript to the PA Holdings case is that the UTT considered the application of the ‘Ramsay’ anti-avoidance approach in determining whether the dividend payments fell to be treated as employment income.
The transcript of the PA Holdings case helpfully includes a summary of principles based on anti-avoidance case law subsequent to the Ramsay decision. This provides a useful update on the development of the Ramsay principle following that case law. A transcript of the UTT decision in the PA Holdings case is available from the British and Irish Legal Information Institute (BAILII) website.
Cause for Concern?
As indicated above, the circumstances in the PA Holdings case which resulted in a Class 1 NIC change on dividends were quite unusual. It seems unlikely that HMRC would seek Class 1 NIC in cases involving more conventional remuneration planning.
However, if HMRC does adopt an aggressive line, they could perhaps be referred to their own guidance in the National Insurance Manual (at NIM2115):
“Dividends are derived from a shareholding and not employment. They cannot therefore be classed as earnings and do not attract NICs”.
Following comments made by the Court of Appeal in the recent Gaines-Cooper case that HMRC should be bound by its own guidance, the above HMRC statement in NIM2115 may prove to be helpful in any argument against a suggested Class 1 NIC charge on dividends. This is provided, of course, that the dividends are lawfully voted and paid.
The above article is reproduced from ‘Practice Update’ (September/October 2010), a tax Newsletter produced by Mark McLaughlin Associates Ltd. To download current and past editions of Practice Update, see the Newsletters section.