The First-tier Tribunal (FTT) has decided in Manthorpe Building Products Limited v HMRC9, following the Court of Appeal decision in HMRC v PA Holdings Limited10, that income tax and NICs were due on bonuses paid to directors that were structured as dividends.

The essence of the scheme was that the appellant company (the Appellant), the employing company, resolved to implement a bonus plan for Mr and Mrs Pochciol, a husband and wife, who between them were the ultimate controlling shareholders of the Appellant and the key directors of the Appellant, the Appellant’s holding company and a second subsidiary of that holding company.

Under the arrangement, the Appellant formed a UK resident unlimited company called Manthorpe Investment Services (Manthorpe Investments). The Appellant itself always held the voting shares in Manthorpe Investments. It made a capital contribution of £1,050,000 to Manthorpe Investments and then subscribed 10,000 1p shares which carried the right to a priority dividend of anything between nil and £1,000,000, payable on or shortly after 30 September 2004. The Appellant’s bonus plan envisaged that if the Appellant’s sales for August and September 2004 reached or exceeded £1,000,000 (a 4.4% increase on sales for the comparable period in 2003) Mr and Mrs Pochciol would receive £800,000 and £200,000 respectively, as their entitlement under the bonus plan. If the targets were not achieved they would receive the lower, so called “guaranteed”, amount of £875,000, rather than £1,000,000, between them. The 1p shares were then transferred to Mr and Mrs Pochciol in the ratio 80/20. The intention of this transfer to Mr and Mrs Pochciol was that the bonus plan would be effected via the share rights of Manthorpe Investments. If the sales targets were achieved, dividends would then be paid in the amounts of £800,000 and £200,000 to Mr and Mrs Pochciol, whereas if the targets were not achieved it was envisaged that there would be a priority repayment of capital on the 1p shares, or a redemption of those shares, for the aggregate amount of the guaranteed bonus figure of £875,000. The targets were in fact achieved and the dividends of £800,000 and £200,000 were paid.

Consistently with the conclusions of the FTT in the PA Holdings case, the Appellant conceded that the dividend payments by Manthorpe Investments were remuneration for Mr and Mrs Pochciol for income tax purposes. Since, however, they were also dividends and since section 20(2) Income and Corporation Taxes Act 1988 (ICTA) (now rewritten to the Corporation Tax Act 2009 sections 210(2), 985(2), (3), 986(2), (3), 999(3), (4), 1000(2),(3)) provided that “no distribution which is chargeable under Schedule F shall be chargeable under any other provision of the Income Tax Acts”, it was contended, consistently with PA Holdings, that this “tie-breaker” section precluded taxation of the dividends as remuneration and thus eliminated any liability on the part of the Appellant to deduct and account for tax under the PAYE legislation.

The FTT had no hesitation in dismissing the Appellant’s arguments. It held:  

“Our decisions on the PAYE issue and the NIC issue are as follows:  

  • The Appellant in this case has already conceded that in a realistic sense the dividend machinery was just a mechanism to deliver remuneration, and that the only defence therefore to liability on the part of the Appellant for PAYE tax was the feature that section 20(2) was the tie-breaker that eliminated the PAYE liability, and required the dividends from Manthorpe Investments to be taxed simply as dividends.
  • Quite apart from that concession on the part of the Appellant, we would unhesitatingly have reached the conclusion that the dividend payments were in reality remuneration. In this regard, the findings of the two Tribunals in the PA Holdings case in any event admitted of no other possible conclusion, and we agree with Mr Gammie to the extent at least that the facts of this case were yet more consistent with this conclusion than the facts in the PA Holdings case.
  • It follows therefore from the fact that the Court of Appeal has allowed HMRC’s PAYE appeal in the PA Holdings case; has concluded that the only charge to income tax in the PA Holdings case was to tax on employment income, and that section 20(2) Taxes Act is irrelevant and that it provides no exemption from PAYE liabilities, that the present Appellant’s contention which relies entirely on the application of section 20(2) collapses.
  • We also dismiss the Appellant’s NIC appeal. The Court of Appeal has endorsed the findings of the two earlier Tribunals in the PA Holdings case to the effect that the NIC conclusion is based, not on the application of the detailed rules in relation to shares, but on the simple proposition that the dividends were simply earnings for NIC purposes. That was Mr Gammie’s contention in this case, and in the light of the fact that the Court of Appeal has endorsed just this analysis of the NIC issue that the two earlier Tribunals had reached in the PA Holdings case, and in the light of the fact that we anyway agree with this analysis, the Appellant’s NIC appeal is dismissed.”

The FTT also decided that they could have reached the same decision on different grounds, including the use of the Ramsay principle. It said:

“The third basis on which we might have decided this case on the PAYE issue is the alternative basis shortly considered by the Court of Appeal in the PA Holdings case, namely on a Ramsay basis of applying the law, interpreted purposively, to the facts, analysed realistically. This approach entirely tallies with the approach that we have already considered in relation to the slightly more technical issue of whether we regarded the payment to Manthorpe Investments to be a true capital contribution, and the receipt of that amount as a profit that could be paid as dividend by Manthorpe Investments.”  

This case demonstrates that highly artificial remuneration planning, along the lines of that considered in PA Holdings, is unlikely to be well received by the Courts.