Peter Harrup of PKF
Business Finance: Peter Harrup of PKF warns of HMRC efforts to tax dividends as salary
Wednesday, January 25, 2012
5:48 PM
FOR many years it has been common knowledge that company owner-managers can save on their Income Tax and National Insurance bills by extracting more of their profits from the company by way of dividends rather than taking a larger salary.
Naturally, HM Revenue & Customs (HMRC) is aware of this issue and takes an active interest in those who try to push this basic planning technique to extremes.
The implications of the recent Court of Appeal ruling in P A Holdings Ltd v HMRC may prove to be wide ranging for employers that pay dividends to employees as part of their rewards strategy.
Many would assume that a dividend must be taxed as such. Unfortunately, in this case, the court decided that certain dividends paid to directors and employees should be liable to both PAYE and NICs and that provisions in the rules for dividends did not apply.
If this case establishes a wide precedent for the treatment of dividends paid to staff, many companies could face unexpected tax liabilities. The ruling effectively said that the tax position should be decided taking account of the arrangements as a whole and applying a purposive interpretation of the legislation. Therefore, if a payment is intrinsically to reward employees it should be taxed as income.
The legislation in this area has changed significantly since the tax years under dispute in this case and, if anything, the possibility that dividends paid to employees will be taxed as earnings is even greater as the disguised remuneration provisions may well apply in the same circumstances today.
Those that might be particularly vulnerable are family companies that use alphabet share arrangements with differential dividends and users of loan waivers to allow certain shareholders to get “personalised” dividends. Family companies which have only a single class of shares are unlikely to be challenged on this basis and can continue to use dividends to extract profits tax-efficiently.
Simplification of small business taxation, aimed at cutting paperwork costs for SMEs, is on the Government’s agenda with a report due from the Office of Tax Simplification (OTS) before Budget 2012. I doubt that the OTS would seek to simplify away the tax advantages of taking dividends but, if an overhaul does materialise, the Government might be tempted to seek some form of simplification gain for itself. Fortunately, such major changes are unlikely for 2012/13.
Business owners can continue to take part of their company’s profits in the form of dividends but, in this climate, it would be wise to seek expert on advice whether current arrangements are robust and sustainable for the future.
