The Court of Appeal’s decision in PA Holdings is now final. HMRC’s victory in that case could pave the way for the department to challenge long accepted tax planning techniques involving dividends.
Rarely can an innocent sentence on a government website have had such potentially devastating consequences for large numbers of (non-)taxpayers.
On 11 April, under the heading ‘PA Holdings Ltd has withdrawn its appeal to the Supreme Court’ in the ‘What’s new’ section of HMRC’s website, the department revealed that: ‘The judgment in the Court of Appeal is now final. HMRC will be contacting those whose appeals remain open or are stayed pending the outcome of this case’.
A recap of the case
For those that do not remember the details of this case, a quick overview might be helpful.
From 2000/01 to 2002/03, the company entered into carefully constructed arrangements under which it paid ‘bonuses’ to employees in the form of dividends in a company specially set up for the purpose. Subtlety was not deemed necessary, since the company did not try to hide the fact that it was converting bonuses for senior employees into dividends, thereby slashing the effective tax rates for both employer and employee.
The tax treatment used by the company relied upon a very careful reading of the strict wording of the underlying legislation. Its initial conclusion was that the payments did not count as earnings for NIC purposes, although it acknowledged that income tax was due. However, it considered that the old Schedule F, which applied to dividends overrode the old Schedule E, which was payable on employment income. This arose from a tie-breaker provided by ICTA 1988 s 20(2).
It has to be said that many learned commentators were of the same opinion. While PA’s failure to succeed on the NIC point did not raise that many eyebrows, Lord Justice Moses’s purposive interpretation of the income tax legislation in the Court of Appeal, concurred with by his two colleagues but overturning both First-tier and Upper Tribunal rulings, was deemed to be strange enough to warrant appeal to the Supreme Court.
The learned judge had summed up by saying: ‘In the instant appeal, PA decided that its employees should receive a bonus, Mourant [the trustee] identified which of the employees, from the list provided by PA, should receive a bonus and those employees received a bonus. That, to adopt the dismissive terms of Special Commissioner de Voil in DTE [DTE Financial Services Ltd v Wilson (2001) 74 TC 14], was the beginning and end of the matter. It is, in my view, the beginning and end of these appeals.’
Until PA Holdings confirmed that it did not intend to appeal, some might have seen this as more an example of wish fulfilment than considered legal analysis.
What next?
The announcement last week puts paid to the idea that this decision could be overturned and means that PA Holdings will now have to stump up all of the tax and NIC that it had originally attempted to avoid. In my article published 15 months ago (‘PA Holdings and dividends for employees’, Tax Journal, dated 20 January 2012), I speculated about the potential impact should PA Holdings not eventually succeed in overturning HMRC’s appeal court victory. As we have seen above, HMRC is clearly intending to assess employment income tax and NIC in a number of other similar cases. Clearly, anybody with an artificial scheme that closely mirrors the one outlined in this article should be fearful of an imminent HMRC attack.
More interesting questions arise around the five Shakespearean scenarios that were outlined in the earlier article. The ones that are most likely to provoke the ire of HMRC could be with regard to:
There is every reason to think that our esteemed revenue authority might feel that the first two of these scenarios would be fair game for a PA Holdings style attack. In each case, payments that would normally be charged to income tax and NIC as remuneration have been converted into dividends, thereby costing the exchequer much needed revenue.
However, the last scenario has a similar flavour to it but is much more commonly used and any attack could be seen as politically unpopular, whether or not it could be justified legally.
If family companies are attacked then, within the next two or three years, we might all have completely forgotten some of these tax planning techniques. Like the use of employee benefit trusts to pay loans, new legislation or even the interpretation of old legislation could have made them a thing of the past.
It has also been suggested by Stephen Woodhouse (‘The proposed GAAR: the impact on employment taxes’, TaxJournal.com, dated 3 July 2012), that the general anti-abuse rule might scupper some plans of this type. While this could well ultimately prove to be the case, at the moment one imagines that HMRC might not have enough confidence in this new legislation to apply it in this way. Further, it may well have much bigger fish to fry in the early years of the GAAR.
Even so, anyone indulging in planning of this type should seriously consider the potential consequences in the light of last week’s surprise decision.
Philip Fisher
Human capital partner, BDO
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