In a recent case (R Jones, J Jones v HMRC) that initially appears surprising, the First-Tier Tribunal determined that dividends declared by a recruitment consultancy company, which subsequently went into insolvent liquidation, were not unlawful.
The company had been struggling but they were still forecast to make profits at the time dividends were declared. Unexpectedly, the company’s invoice finance providers demanded immediate repayment of sums owed. It appears that this was what forced the company into liquidation as they were not able to obtain the funds on demand and were unable to find alternative finance.
On appointing liquidators, the directors were advised to reclassify the sums paid as dividends as salary as there was a risk that they could be unlawful. There was no evidence presented as to why they believed this to be the case, and the directors admitted to not fully understanding the advice given. This reclassification took place, but the accounts and company records were not fully updated to reflect this.
The directors declared the salaries on their tax returns, but stated that tax had been deducted, which was not the case as when the payments were made, they were treated as dividends. HMRC argued there had been a wilful failure by the business to deduct PAYE and National Insurance on these payments of salary, and were therefore seeking to recover the tax from Mr and Mrs Jones.
The directors appealed arguing that the payments had been intended as interim dividends.
The First-tier Tribunal decided that the reclassification amounted to “nothing more than a flawed analysis of the transactions which had taken place”. The sums were clearly intended as dividends and they did not see any reason as to why they should have been unlawful. They did acknowledge that the position may have been different if the dividends were unlawful.
The taxpayers’ appeal was therefore allowed, with the sums taxable as dividends as originally intended.
This case highlights the importance of taking correct advice, and of ensuring that dividends are declared in a lawful manner with proper records made. The taxpayers in this case were able to get the desired outcome, but the position would likely have been resolved more easily if proper advice was taken at the time.