Confirmation that Dividend Waivers should be treated with Caution

The recent First-Tier Tribunal (FTT) case of Donovan & McLaren v HMRC has confirmed that regular dividend waivers constitute a settlement for Income Tax purposes.

HMRC’s CASE

It was argued by HMRC that the effect of the dividend waivers and the intention of them was to allow higher dividends to be paid to the two directors’ wives than their respective shareholdings entitled and lower dividends to be received by the two directors.

HMRC stated that according to ITTOIA 2005 s.620 the directors’ dividend waivers and the consequent payment of dividends to their wives constituted an arrangement that can be defined as a ‘settlement’ whereby the directors were the settlors. HMRC inferred that the directors waived entitlement to dividends as part of a plan that dividend income otherwise due to the directors would be paid to their wives, therefore constituting an ‘arrangement’ under the settlements legislation. It was argued that this scheme was used for tax avoidance purposes so that the directors and their wives could reduce this aggregate liability income tax by using the wives’ unused basic rate band of tax.

HMRC rejected the alleged commercial rationale for executing the dividend waiver which was to maintain reserves and cash balances in order to accumulate sufficient of each to fund the purchase of the company’s own freehold property. They contended that this could have been more easily achieved by voting a lower rate of dividend.

The settlements legislation also requires an element of bounty to be part of the arrangement. Consequently, HMRC argued that the directors’ arrangement was not one that was entered into at arm’s length and the arrangement therefore contained an element of bounty.

APPELLANTS’ CASE

The two directors failed to provide any evidence to defend their position other than inferences from previous correspondence submitted by them and their accountant. Furthermore it had been admitted by the appellants and their agent in a letter to HMRC that ‘dividend waivers are by their very nature not on arm’s length or commercial’ which substantially weakened their appeal.

They had also argued that structuring the waivers as they did was tax efficient and made commercial sense.

FTT DECISION

The FTT found that the directors had waived their entitlement to dividends as part of a plan to ensure that the dividend income became payable to their wives so as to reduce their aggregate liability to Income Tax. The income which arises from the dividend waiver arrangement clearly arose during the lives of the director and the dividend income paid to their wives from their shares together with the dividend rights attached to them are benefits enjoyed by the directors’ wives. On the balance of probabilities the FTT accepted the submissions by HMRC; including the opinion that there was no commercial purpose for the waivers and that they did not have taken place at arm’s length.

The FTT also found that there was a lack of sufficient distributable reserves within the company were it not for the directors waiving the dividends.

Finally, they rejected the claim by the directors that the discovery assessments raised by HMRC were invalid. All appeals asserted by the two directors were dismissed.

CONCLUSION

This case serves as a reminder that companies need to be cautious when considering the use of dividend waivers. The definition of a ‘settlement’ is wide-ranging and to avoid being caught in an arrangement which may constitute a settlement arrangement it is best to seek professional advice.

There are options that remain effective for efficient tax planning through family companies that can be used without the need for dividend waivers. Seeking professional advice in advance is preferable to finding out the planning did not work in the Courts.

Employer-Financed Retirement Benefit Schemes (EFRBS) Settlement Opportunity

HMRC Offer EFRBS Settlement Opportunity

HMRC are giving employers the chance to settle open enquiries into the use of employer-financed retirement benefit schemes (EFRBS).

The settlement opportunity applies to contributions made by employers on or after 6 April 2006 and before 6 April 2011.

HMRC are of the belief that such arrangements do not work and therefore the settlements will avoid the need to take part in potentially costly litigation, thus benefiting both sides.

Firms will have until 31 December 2013 to enter into an agreement with HMRC.

Two Options Available

They will then be required to choose one of the following two options offered by HMRC:

i) No Corporation Tax deduction can be claimed on contributions to an EFRBS until the relevant benefits are paid out by the scheme, HMRC also expect PAYE and NICs will be due when they are paid out or

ii) A Corporation Tax deduction can be claimed when contributions are made to the EFRBS.  However, when those contributions are made they will be subject to PAYE and National Insurance contributions.

If an employer chooses to settle with HMRC by choosing one of these options they will have until 30 June 2014 to finalise the arrangement.

Interest & Penalties

Under option 1 interest will run from 9 months and 1 day from the end of the accounting period for which the additional amounts are due.

Under option 2 interest will run from 19 April following the end of the tax year in which allocations were made to the date the PAYE Income Tax and NIC is paid to HMRC.

HMRC have said that they will only seek penalties regarding any tax due in exceptional circumstances. However this is caveated by saying that every case will turn on its own facts.