For several years until 2005, some companies used an arrangement
for paying bonuses which involved employees receiving a particular
type of share in a UK tax resident company (often specially created
for this purpose). Those shares then paid out a dividend shortly
after employees received them. Following payment of the dividend,
the shares then effectively ceased to have any value at all: i.e.
they were just created to pay the dividend.
The supposed tax efficiency of this scheme sprung from the
intricacies of the tax system. It was believed that particular
provisions in the tax code meant that employees were not taxable on
receiving this particular form of share; dividends could not be
recharacterised as bonuses and so would suffer tax at a more
favourable rate than employment income; and finally that dividends
would also escape National Insurance contributions (NICs).
In recent years, much of the optimism in that tax planning has been
shown to be ill-founded. The Courts have in several cases supported
the Revenue and have eroded these supposed tax advantages. In 2005
the Government changed the legislation so that these schemes are
expressly not effective.
The most recent judgement is in a case which had already at a lower
tier of the judicial process been authority for the dividends being
subject to NICs. The Court of Appeal has held that the fact that
tax legislation included a specific provision saying that dividends
could only be taxed as dividends still did not prevent these types
of dividends being taxable as bonuses. This means that they did not
have the benefit of a tax credit and were subject to deduction of
tax under PAYE at the employee's full marginal rate. In any
event, even if this particular piece of legislation had been
relevant, the Court of Appeal said that it would under the Ramsay
doctrine (which looks through form and taxes on the basis of
substance) have held that these dividends should be taxable as
bonuses.
Companies still defending these schemes will be discouraged by this
result. It is not clear whether there will be a further appeal.
Some of the reasons given by the Court of Appeal are surprising
both in the context of these schemes and more generally. While many
companies at the time of implementation were advised to put in
place retention and/or indemnity arrangements with their employees
in case of this eventuality, with the passage of time, recovering
these amounts could now be difficult.
To read the Court of Appeal decision, please click here.
This article was written for Law-Now, CMS Cameron McKenna's free online information service. To register for Law-Now, please go to www.law-now.com/law-now/mondaq
Law-Now information is for general purposes and guidance only. The information and opinions expressed in all Law-Now articles are not necessarily comprehensive and do not purport to give professional or legal advice. All Law-Now information relates to circumstances prevailing at the date of its original publication and may not have been updated to reflect subsequent developments.
The original publication date for this article was 05/12/11.