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.
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.
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.
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.
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.