A new tax on dividends - revisited. By Nichola Ross Martin

I'm not an expert, but I would tend to agree with Nichola that traditional tax planning, ie minimal salary and dividend strategy, is unlikely to be affected (at least by this particular legislation).

My own reading of Section 447 is that something must be done to affect the securities in question. My personal opinion is that alphabet shares and other schemes are the ones more likely to be affected here.

It is, of course, quite possible that the Revenue might try to attack OMBs using this legislation, but whether they will succeed in the courts is another matter. We've seen recently the Revenue's climbdown with Operation Gourmet. At first, they thought they were onto a winner, even though many in the profession didn't agree with them. However, the Revenue have had to yield ground time and again, until finally they've practically given up the fight.

So even if they should try to attack OMBs using Section 447 to attack salary/dividend planning, there's no guarantee they'll win. The question is, will we and/or our clients have the stomach for the fight?

Fundamentally if you do anything other than pay salary out of a company (and that includes pension contributions!) then there is a risk that HMRC will use some of the Treasury's careful drafted befuddlement legislation to have a pop at you.

If any accountant runs scared of that sort of threat then they really ought to hang up their slide rule and take up fishing or something.

The defence against HMRC having a go at incorporated businesses is not legislation it is PR. Any attack would be a PR disaster for this govenment and an absolute gift to the opposition.

Going for the envy vote by targetting IT contractors and big salaried city slickers is one thing. Bankrupting Aunty Ethel's hat shop is quite another.

NeilW

The reason that this area is a mess is because succesive governments have promised not to raise income tax - but they need more money. This has lead to other complications to disguise the tax take.

So Mr Brown, show us your leadership qualities and scrap NIC's altogether. While you are about it get rid of the different income tax rates for savings and dividends. Raise the rates of income tax and corporation tax to recover the lost revenue - then there will be no reason to prefer one source of income to another. Of course the standard rate of income tax will have to rise to 30% or more, but might as well be honest eh.

Of course, to show green credentials you could always add standard rate VAT to all energy bills which would help a bit. Have to increase pensions and benefit payments though so people didn't freeze to death in winter.

Simple, isn't it.

s 716A TEPA 2003 "Priority rule for dividends etc of UK Resident companies etc": says

Any income, so far as it falls within:

a)Part 2, 9 or 10 of this Act,

A N D [not 'or'!]

b)Chapter 3 of Part 4 of ITTOIA 2005 (dividends etc from UK resident companies etc) is dealt with under Chapter 3 of Part 4 of ITTOIA 2005.

The income addressed by s446 does not fall into Part 2, 9 or 10, so is the protection of s716A available?

I really don't think that small firms need to worry about advice regarding incorporation at the moment. Here is a quote from Ms Primarolo :

Standing Committee debates on FA (No 2) 2005 21 June 2005. Dawn Primarolo says:

'there is no connection between the changes proposed in this clause and schedule to tackle contrived avoidance schemes and last year's discussion paper on the taxation of small businesses, which focusses on the strategic issues relating to the taxation and treatment of the legal forms used by small businesses'.

There is more in this vein by which I understand that as a policy matter these measures will not be used against small companies on the mere pretext that they have incorporated to save tax. Government's view would seem to be that the development of a new structure for taxing small businesses is the outcome for them to focus on, and they will seek to deal with issues around incorporation to save tax through this new policy, which is a medium term objective. My understanding is that there is an unstated intention not to "meddle" in the short term and allow policy to be drawn up which will deal with the issues (or perceived issues) in an orderly way. (Rather than going down silly routes from which they have to back up later a la NCD's).

Is there anything to stop the Revenue taxing an amount under s716A as a dividend, and charging NIC (and perhaps additional income tax) under s447(4) where they believe "something has been done"?

Is "something being done" payment of a low salary of £6,000 and a £200,000 dividend or is that an "arrangement" to avoid NIC?

Is s716A capable of covering NIC at all in the above case? It refers to Chapter 3 Part 4 of ITTOIA 2005, which imposes an "income tax" charge on dividends. It is of course silent on NIC perhaps leaving the door open for that to be charged under s447(4) in the above case.

Then there is the language used in the discussion paper "Small companies, the self-employed and the tax system” issued in December 2004, co-incidentally when the amended s447(4) was introduced.

In that document , the Revenue use the following example “4.27 Becky’s company is paying her partly in dividends, which can be seen as representing both a return for the labour she has provided to the business, and her return on any capital she may have invested in the business. She is able to enjoy the benefit of the overall lower effective rate of tax that applies to dividends”.

That discussion document ends by asking "whether the Government should consider segmenting owner-managers of companies from other company owners for tax purposes".

Whilst the Government have confirmed that they do not intend to proceed any further with that particular review, I do think we can see how the Revenue, Treasury and Government are thinking. This is a quote from a Revenue publication...........on IR35 guidance!

“The worker can then take the money out of the …….company in the form of dividends instead of salary. Dividends are not liable to NICs so the worker can pay less in NICs than either a conventional employee or a self-employed person. The individual thus gains an unfair advantage over other employees”.

I do think cases where low salaries and high dividends are paid to owner managers carry some risk of being challenged, however the point may be moot given a possible alignment of the rules for Income Tax and NIC announced in the last Budget. This could feasibly see an introduction of NIC on close company dividends, particularly where owner managers are concerned. NIC on dividends is a long-standing goal of a particular think tank close to the left of the Labour Party.

In my view, all bets are off. The Revenue is under tremendous pressure from the Treasury to increase the tax yield, no doubt at minimum cost. This could mean that the soft targets are first on the list. I mean, who would have thought 10 years ago the Revenue would take a case to The House of Lords involving the payment of dividends to a spouse!

Paul O'Connell
Francis Clark Tax Consultancy Limited
www.fctc.co.uk
01626 206206

I would agree that Socrates is asking the right question here. Much as I respect the views of eminent Counsel, I am not sure I agree with Mr Thornhill's optimism.

Section 716A is a tie-breaker for situations where the same income could otherwise be taxable under both (a) Part 2, 9 or 10 ITEPA 2003 and (b) Chapter 3 of Part 4 of ITTOIA 2005. In such a case, the dividends taxation rules take precedence. However, Section 447 is in Part 7 of ITEPA, and we don't have any tie-breaker between that Part and ITTOIA. It is long-established that when the same income could be taxed under two different sections, HMRC can choose which to apply.

This is where professional judgement, not to say common sense, comes in. I can't see HMRC taking this point in relation to the normal situation of a shareholder in a small company taking a small salary and thereby enabling the company to pay large dividends on all the shares. They have better things to do with their time. However, if you start using alphabet shares to provide differential levels of dividend, reflecting work done by different individuals for the company, particularly if this is linked to some form of "salary sacrifice", then frankly you deserve what's coming to you. As professionals, it falls to us to use our judgement to understand where the boundaries of what is acceptable lie.

I agree with Protagoras, however I think that it is fair to say that whatever our views on the matter, the boundaries of what HMRC view as acceptable and unacceptable planning have changed, and indeed continue to change. This is not about running scared, but is about us as professionals needing to understand that change and react to it.

I go back to my earlier final comment to illustrate my point.

Who would have thought 10 years ago that the widespread practice of paying dividends to a client's spouse would be reagrded as unacceptable planning by the Revenue? Not me and I suspect not any of our readers here, but is anyone really still undertaking this planning without warning the client about the possible outcome of Arctic Systems? I thought not.

It is true to say that the Revenue should have better things to do with their time and here I agree with Protagoras, however the reality is sometimes very different. I wonder how many investigation cases our readers have seen over the years where they have made that exact same comment?

In this changing environment, where the Treasury are attempting to blur the lines between planning, avoidance and evasion, the concern has got to be that long established planning techniques, such as those employed in Arctic Systems, are up for a challenge.

Therefore I suggest that any potentially affected client is warned that legislation exists which could be used to attack a low salary and high dividend structure.

That way you avoid that all too dificult question "why didn't you tell me".

Paul O'Connell
Francis Clark Tax Consultancy Limited
www.fctc.co.uk
01626 206206

... that I had taken the view that s447(4) doesn't override s716A which still says that dividends are taxed as dividends. S447 doesn't actually mention dividends, so I'm not sure if the introduction of the avoidance test achieves anything. I don't know where Andrew Thornhill is coming from on this but my main concern was that there could be double taxation, which Ms Primorolo's comments don't exactly lay to rest. Some commentators only go so far as to say that HMRC may have the option as to which charge to levy. In that case, at least in the short term, if Mr Client continues to draw his small salary and big dividends then he won't be any worse off if HMRC then come and say they want the NIC, except perhaps for some interest. I can't see that penalties could be involved. If you throw in the towel and tell the cleint to take a commercial salary then haven't you done HMRC's job for them without an argument?

However, although there is a presumption against double taxation, if it were clear that that was what Parliament intended in avoidance cases then is there anything to stop this? I couldn't find any specific precedent on the point. If that is what was intended the s716A v s447(4) point becomes redundant & there is no conflict between the two.

However, there are other technical arguments as to whether 'something has been done', as has already been mentioned. Also, if HMRC allege tax has been avoided this begs the question: how much. If you take a small salary and big dividends you pay less tax (or rather NICs) than you would otherwise have paid. But have you avoided tax any more than if you pay a pension payment. The Courts have always given short shrift to an argument against a charge that you could have paid less tax by carrying out a transaction differently so I don't see why the argument doesn't work the other way around. I gather HMRC are compiling lists of typical salaries but the 'right' amount of tax that any private company director shareholder should pay cannot be objectively determined so I personally don't believe it is simply a question of fact. I also cannot believe that the Courts will allow HMRC to just make up their own figures.

There's no denying Andrew Gotch's practical experience and no-one should minimise the danger but I think HMRC are fundamentally wrong. I've also seen a suggestion that the PG's comments could be used on the basis of Pepper v Hart to determine the intentions and she only refers to complex contrived arrangements so was probably thinking about City bonuses.

One way or another there's plenty of ammo in the armoury yet.

My view is that the declaration of a divi is NOT something that is done that affects a share, for what it's worth (perhaps Laird helps here?). That may well help for pre-2/12/04 share issues where the shares have not been altered in any way since that date. For post-2/12/04 share issues though, that doesn't matter if a purpose of issuing the share (which does affect it) was to avoid tax/NIC. I think it's inconceivable that a divi would not be regarded as a benefit and the old s.80 FA 1988 was widely accepted to have that scope.

A further substantial mischief that needs to be addressed is that relating to the operation of PAYE. See s.698 ITEPA passim. The result could be, and I think is, that the tax on a divi within s.447 is potentially recoverable from the employer by way of determination if PAYE is not accounted for. Further good reason for saying that the payer has to take a sustainable view of the status of the payment when made, as does the recipient when completing his return.

The Crown option/prerogative point is I think a red herring on reflection. The Revenue would simply issue a closure notice/dicovery asst taxing the payment under 447 - and then it would fall to the t/p to prove that the Revenue's was wrong - a heavy burden to discharge.

Scaremongering? I think not. Correctly applying a purposive construction along BMBF lines to what is anti-avoidance legislation seems to my eye to give only one possible answer. Pepper v Hart is only relevant where the legislation is obscure, ambiguous or leads to an absurdity. None of those criteria seem to me to be present here; the law 'does what it says on the tin', to coin a cliche. In any case the FST was not commenting on what the legislation meant, but giving an example of what was caught that can hardly be seen as exhaustive.

It just gets worse, doesn't it?

to see that after recent experience with 660A anyone can still doubt that the revision of 447 will be applied to small businesses - in due course. What about an incorporation where the principal was previously drawing 80k after tax? When he incorporates, and as advised takes a nugatory salary and the rest as dividends, what are the chances of Commissioners not agreeing that the shares were issued partly at least to avoid tax/NIC? Particularly since his adviser will no doubt have been trumpeting the savings available in his advice letters, which the Revenue will be perfectly entitled to see? No defence at all as far as I can see. Relying on very non-specific comments by the FST is a high risk strategy. A further point that everyone is missing is that this is actually a self assessment responsibility - so a sustainable view that the conditions in 447 etc are NOT satisfied is required to avoid penalties if you lose a challenge - or at least may be required, since the operation of Crown prerogative is untested under SA, I believe. Does SA imply a taxpayer prerogative? Interesting point but a whole other article... But I can confirm Darren's point about the Revenue's aggression in this field in pre-2/12/04 cases; I have cases working where the local Inspector is being supported by SCIO, SIS and the Rev Solicitor - there is a lot of technical investment in winning the point. If that's their position for periods before s.447 was amended, does anyone seriously think that they won't use amendments that address precisely that behaviour equally aggressively? As with 660A, if you wave a red rag at the Revenue long enough it will charge, as it has done with the amendments to 447. I also agree with Socrates on the Thornhill view. At the risk of being a Cassandra figure, this is the calm before the storm!
Andrew Gotch
01869 232778

Having said that issuing alphabet shares for no consideration to simply pay disguised bonuses could well be vulnerable - but whether this section achieves any aim of catching these sums is a moot point - and as it does create a self-assessment obligation if it applies (would some fool/hero care to apply for a post-transaction ruling under COP10?) it would be very easy for the revenue to indicate that they think it applies in a simple dividend situation as give us the headache of dealing with it - which they conspicuously have not done. In 99 out of 100 cases I think I would sleep soundly.

Andrew Gotch seems to feel that this can be applied where a shareholder director simply draws a dividend and avoids NIC but...

The legislation uses the term "benefit" without definition and that raises the issue as to its meaning in this context. Using the Ramsay principle as espoused by Hoffman in Westmoreland v MacNiven does this have a narrow technical meaning or a broad meaning? The only other use of the term seems confined to benefits in an empoyment sense - If the legislator had intended distribution as defined by s209, which encompasses the vast majority of methods by which value is returned to or distributed to shareholders then surely such a term would have been used, and yet it is expressly not a benefit-in-kind but a benefit. This would suggest an advantage over and above that received by another holder of the same class of shares, or similar shares, reinforced by the exclusion of benefits otherwise chargeable to income tax unless "something has been done which affects the employment-related securities" in s447(4) and again in s449(1A) - as part of a scheme or arrangement (in the Court of Appeal decision in Arctic deciding whether or not to pay a dividend was NOT part of a scheme or arrangement) the MAIN purpose or one of the MAIN purposes is the avoidance of tax or NIC. Avoidance is still rather more than simply mitigation and issuing shares and taking a legitimate taxable dividend thereon is still mitigation not avoidance IMHO.

This legislation replaced a previous charge which was that that applied to dependent subsidiaries where an employee was given shares in a (typically) subsidiary company where value could be manipulated by related company transactions. In attempting to devine the purpose of the legislator the mischief that legislation is intended to remedy is an aid to interpretation. Simple dividends, a right that all shareholders enjoy do not, if declared, represent "something which has been done to a security" - although paying a dividend into a subsidiary which enhances its value and diminishes that of another company might and a depreciatory distribution might.

I do not believe that this shoddy bit of badly worded obscurity was intended for the purpose suggested by Andrew Gotch - although I would never put it past the revenue to try to use it in an unintended fashion - and it is scaremongering to suggest that it does.

It is noticeable that the revenue explanation in the comments on Form 42 uses the term "special dividend" as an example of such a benefit s though we all understand what this might be - another term without statutory meaning or significance - how often have you come across a "special dividend" I wonder. My opinion is that this is an attempt to strengthen and replace the concept of a liability in connection with a dependent subsidiary and only where a charge could be considered to be analogous will it have an application.

There is no ruling as such, and HMRC have not yet even published the chapter of their Employment Related Securities manual that covers s.447. You have to remember that prior to 2002/03 HMRC itself had no proper guidance on shares and share schemes - this is new ground for inspectors too.
We are all just trying to work out what it all possibly means and what will conceivably happen in practice.

Nichola Ross Martin
Editor, AccountingWEB