Dividends, salary and alphabet shares – an update

Dividends, salary and alphabet shares - an update

Common tax efficient strategies such as using dividends and alphabet shares being paid in lieu of actual employee pay have once again come under the spotlight.

The case of PA Holdings has been going through the courts for several years. It was due to go to a final hearing in the Supreme Court in July of this year. However, the company has decided to withdraw their appeal. This means that the Court of Appeal decision is now legally binding.

To summarise the story, the case itself concerns whether dividends are employee income or not. This inevitably gives rise to concerns about whether dividends are going to be subject to National Insurance in the future. In the case of PA Holdings one accounting year they paid their employees an actual salary ‘bonus’. In the following year they decided that their employees would once again receive a ‘bonus’; however, this time it was received by way of dividend. As a result the employees pay less income tax with no national insurance charges for either the employee or employer. The Court of Appeal decided that they would completely ignore the avoidance scheme structure and looked directly at what the employees received i.e. the actual substance of the transaction. It was calculated on the same principles, received in the same way and was ‘sold’ to the employees as a bonus. Therefore it was deemed to be employment income and as such the normal PAYE deductions should have been applied.

The circumstances of this case are different those of most smaller owner managed businesses that PAH Accounting deal with. PA Holdings was a larger business with a number of regular staff. Those staff had no actual ownership of any part of the business. To enable a tax/NI efficient bonus to be paid to employees they set up a subsidiary company, offering the staff shares in that subsidiary; however the subsidiary entity did not actually do anything. It was purely a vehicle to receive funds and distribute them as dividends to its employees.

Upon looking it could be deemed that the case is relatively straightforward, the tax avoidance scheme is transparent and therefore the judgment broadly correct; however the concern now would be that HMRC will be looking to extend the principle established from the case beyond the particular circumstances of the case. Many owner-managed businesses have structured their remuneration packages in a similar tax efficient manner to the benefit of shareholder/ directors.

In addition, ‘alphabet’ share schemes featuring several classes of share enabling differing rates of dividend to be paid, could also now be challenged by HMRC using the principles established here. These are particularly vulnerable where the only rights attached to the shares are a right to dividends. It is less likely that HMRC will challenge any arrangements where shares also carry voting rights and have an actual capital value.

HMRC’s approach to the judgment in this case is something that will need to be monitored very carefully.

If you have any queries or issues about how your directors remuneration or that of your employees is structured feel free to get in touch.