HMRC v PA Holdings Ltd gives the appeal decision for a case we commented on in our November 2009 issue. The Upper Tribunal upheld the initial decision that bonuses paid as dividends from a UK resident company should be taxed as dividend income at 25% rather than be taxed at 40%, but held that NICs were still payable. The tribunal made several points of interest regarding the categorisation of remuneration.
As a reminder of the facts, PA Holdings established an offshore employee benefit trust (EBT) into which it paid £24.6m (the amount of the eligible employees’ bonus pool). The money was invested into shares of 1 pence in a Jersey company, Ellastone, by way of capital contribution. The EBT adopted a restricted share plan and eligible employees were granted restricted preference shares in Ellastone. A dividend of 99 pence per share was then paid on the restricted preference shares. The dividend payment was taxed at 25% (with no NICs) giving an income tax and NIC saving on a straight cash bonus of around £6.7m. HMRC sought to challenge the character of the payment arguing that it was more correctly employment income.
The Upper Tribunal (UT) considered three main questions:
- Were the dividends to be regarded as coming from the employees’ employment (and therefore falling within the scope of income tax)?
- Did the payments constitute dividends or ‘other distributions’ (determining whether the payments were taxable as dividends)?
- If the answers to the above were in the affirmative, how did the legislative provisions interact?
In answering the first question the UT had particular regard to the approach in WT Ramsay Ltd v IRC which allows for complicated structures (like the one in PA Holdings) to be viewed not simply as a series of isolated transactions but instead to be considered as a whole. In this instance the UT concluded that the overall objective of PA Holdings was to motivate their employees and that the dominant cause of the dividend was their employment. As a consequence, it was concluded that the payments constituted employment income and could fall within the scope of income tax.
In responding to the second question the UT noted that a distribution would generally have the following characteristics:
- The making of the distribution results in a cost to the company.
- The payment must be in respect of a share or security of the company.
By applying this test the UT could confirm that the dividend payments constituted ‘distributions’ since they were a cost to Ellastone which related to shareholdings within it. The tribunal held that the limited rights of the shares had no bearing on whether they constituted a distribution.
In answering the third question the tribunal noted that the relevant tax legislation clearly stated that an income tax charge on distributions prevented an employment income charge over the same sum. As such the payments would be subject to tax at the dividend rate rather than the income rate (resulting in a tax saving). However, a good portion of the saving was eroded when the tribunal concluded that the legislation did not prevent the distributions from being subject to NICs.
The introduction of anti-avoidance legislation means there is likely to be limited scope for using such structures.