In Richard Jones, Julie Jones v HMRC, the First-tier Tribunal (Tax Chamber) (FTT) has decided that the owners of an insolvent recruitment consultancy do not have to pay employment taxes in respect of dividends paid to them which they subsequently reclassified as salary.
Mr and Mrs Jones (the Appellants) were the director-shareholders of Perfect Change Limited, a recruitment consultancy. Unfortunately, the company entered insolvent liquidation in February 2009.
Before putting the company into liquidation, the Appellants were advised by their accountants that their directors' loan accounts were overdrawn and a liquidator would seek repayment. Mr Jones believed that the reason the accounts were overdrawn was due to interim dividends paid in 2008. The Appellants were advised that there was a risk the liquidator might seek repayment of the interim dividends.
Acting on the advice of their accountants, the Appellants decided to reclassify the sums originally paid by way of dividends as remuneration, subject to PAYE and national insurance.
Following the 'reclassification', the Appellants did not account for the PAYE and national insurance due on what was now classified as salary, or emoluments. HMRC proceeded to seek recovery of the PAYE and national insurance contributions from the Appellants, who appealed the PAYE direction notice and the decision making them liable for NICs, to the FTT.
The FTT had to consider the following:
1.Were the dividends paid unlawfully as a matter of company law?
Dividends can only be paid where distributable profits are available by reference to the company's accounts under sections 836 and 838 of the Companies Act 2006.
2.Were the Appellants personally liable for PAYE on those sums?
Regulation 72 of the Income Tax (Pay As You Earn) Regulations 2003 (the PAYE Regulations), provides that employees can be personally liable for PAYE if "the employee has received relevant payments knowing that the employer wilfully failed to deduct the amount of tax which should have been deducted from those payments.”
3.Were the Appellants personally liable for national insurance contributions on those sums?
Regulation 86 of the Social Security (Contributions) Regulations 2001 (the NICS Regulations), provides that, where there has been a failure to pay any primary contribution which a secondary contributor (the employer) would be liable to pay on behalf of the earner, and "the earner knows that the secondary contributor has wilfully failed to pay the primary contribution which the secondary contributor was liable to pay on behalf of the earner", then the employer is removed and the earner becomes liable for payment.
Both sets of Regulations required actual knowledge, on the part of the employee, and a deliberate act of not paying by the employer.
The Appellants argued, amongst other things, that the required knowledge and intent had to be present at the time that the relevant payments were made. They argued that the interim dividends were lawfully declared because there were sufficient profits available at that time the dividends were declared. The conditions did not fall to be considered retrospectively.
The FTT agreed with the Appellants, and in allowing their appeals said:
"the obligation to deduct PAYE and pay national insurance arises at the time the earnings are paid to the employee. In the present appeal HMRC accept that the payments were dividends when originally paid. There was therefore no obligation to deduct PAYE and pay national insurance at the time those payments were made to Mr and Mrs Jones."
With regard to the 'reclassification' of the dividends as emoluments, the FTT concluded that the reclassification had no effect. In the view of the FTT, the "directors cannot retrospectively alter the nature of the payments simply by deciding to treat them differently…[it] amounted to nothing more than a flawed analysis of the transactions which had taken place."
This is a sensible decision which confirms the time when the requisite knowledge and intent requirements contained in the Regulations fall to be considered and is to be welcomed.
In reaching its decision, the FTT made a distinction between this case and Williams v HMRC, in which the FTT dismissed the taxpayer's appeal against a direction notice under Regulation 72. Although many of the facts were similar, in Williams the taxpayer was aware that dividends could not lawfully be paid at the time he received sums from the company. The sums were therefore treated as drawings and debited to a loan account, which caused it to become overdrawn. The company planned to declare a dividend to clear the loan account, but it was never able to do this because it did not have sufficient distributable reserves. In the Williams case, the company decided to treat Williams as having received sufficient net salary to clear the overdrawn loan account in the knowledge that the company would not pay the PAYE and NICs. In the Jones case, the dividends were lawful, but had they not been, the outcome of the appeals may have been different.