In the case of HMRC -v- PA Holdings [2010] All ER (D) 207
(Jul), the company entered into arrangements under which it was
intended to "re-route" employee bonuses as dividends of a UK
resident company, Ellastone, so that they would be taxed as
dividend income. The First-tier Tribunal found that the payments
were both earnings and distributions.
On appeal from both parties, the Upper Tribunal considered that
there were essentially three questions to be answered:
- Were the dividends to be regarded as coming from the employees'
employment?
- Did the payments constitute dividends or "other distributions"?
- If the answer to both the above questions was yes, how did the
legislative provisions interact?
With regard to the first question, the company's appeal had
challenged the decision of the First-tier Tribunal on the basis
that the First-tier Tribunal had failed to apply correctly the
principles laid down in Hochstrasser -v- Mayer. The court
in Hochstrasser held that in order for a payment to
constitute an emolument of employment it is not sufficient to show
that the payment would not have been made but for the employee's
employment, rather HMRC must show that the employment was the
immediate cause of the payment. The Upper Tribunal also considered
the application of the approach laid down in WT Ramsay Ltd -v-
IRC, whereby a series of pre-ordained transactions entered
into in order to avoid tax can be considered as a composite
transaction, so that tax legislation may be applied to the end
result rather than considering the fiscal consequences of the
individual transactions in isolation. The Upper Tribunal found,
upholding the decision of the First-tier Tribunal, that there was
an "unbroken link" between the payment by the company to the
trustee and the receipt of dividends by the employees, and that the
arrangements including the dividend were made "with the object
of motivating and encouraging employees in the performance of their
duties as employees". Therefore, under both the principles of Hochstrasser and under the Ramsay approach, the
cause of the dividend was the employment.
The second question was also answered in the affirmative. The Upper
Tribunal held that the legislative provisions which set out which
transactions constitute a "distribution" are widely written "to
catch the products of human ingenuity designed to avoid a
transaction being the payment of a dividend" and that they
catch transactions which have two principal characteristics. Those
characteristics are that:
- the making of the distribution results in the incurring of a cost
by, or the passing of value from, a company; and
- the passing of value must be in respect of some share in, or
security of, the company.
The Upper Tribunal found that the money did in fact beneficially
belong to Ellastone, and that while it was expected to pay the
dividend it was not bound to do so. Even though the components of
the composite transaction allowed Ellastone to pay the dividend,
that did not mean that the cost of the payments was not a cost to
Ellastone. It was also confirmed that the possession of substantial
rights (such as voting rights or rights in a winding up) "are
not prerequisites of the nature of the shares for a payment in
respect of them to constitute 'a distribution'". The "thin"
nature of the redeemable preference shares did not prevent this
test from being met. Both characteristics were therefore present,
and the amounts paid to the employees by Ellastone were, therefore,
distributions.
The final question concerned the interaction of the provisions. The
Upper Tribunal confirmed the finding of the First-tier Tribunal
that, once the payments are properly characterised as dividends or
distributions, s.20(2) ICTA 1988 provides in "unambiguous terms"
that if they are chargeable as dividend income they are not
chargeable as employment income. As there is no equivalent
provision in the social security legislation, any characterisation
as a distribution does not prevent the benefit from being earnings
upon which Class 1 NICs are chargeable.
Changes in tax legislation mean that the PA Holdings scheme would
no longer be viable, as an upfront tax charge would arise on
acquisition on the full value of those shares, including the
potential dividend. In addition, if the shares were already in
issue, changes to Chapter 4 of Part 7 ITEPA 2003 bring dividends
under those shares within the charge to tax as employment income
where there is a tax avoidance motive.
However, the decision remains an important one due to the
limitations of the Ramsay approach highlighted by it, and
with regard to the wide scope of application given to the
characterisation of payments as emoluments of employment under Hochstrasser.
Please click on the links below for the other articles in
the July 2010 tax newsletter.
Contacts
John Watson
T: +44 (0)20 7859 1308
E: john.watson@ashurst.com
Richard Palmer
T: +44 (0)20 7859 1289
E: richard.palmer@ashurst.com
Ian Johnson
T: +44 (0)20 7859 1304
E: ian.johnson@ashurst.com
Alexander Cox
T: +44 (0)20 7859 1541
E: alexander.cox@ashurst.com
Paul Miller
T: +44 (0)20 7859 1786
E: paul.miller@ashurst.com
Simon Swann
T: +44 (0)20 7859 1882
E: simon.swann@ashurst.com
This newsletter is not intended to be a comprehensive review of
all developments in the law and practice, or to cover all aspects
of those referred to. Readers should take legal advice before
applying the information contained in this publication to specific
issues or transactions.