Many a company secretary of an owner-manager taking their income mainly as dividends will have noticed the surprise outcome of a high profile case over whether tax and NI can be applied to dividends by HMRC in the same way as salary. The consultancy firm PA Holdings Ltd (PA) conceded defeat, leading to fears that directors/shareholders taking their income mainly by dividends could be subject to HMRC assault.

PA had devised its scheme to avoid the need for its employees to pay PAYE tax and NI on their bonuses, with a special class of share being created that the employees purchased for a nominal price. These shares then had large dividends paid on them – leading to HMRC’s challenge.

The lower tribunal was the first to consider the payments, agreeing in part with HMRC. Although it ruled that the dividends were a disguised bonus, it also didn’t think it possible to ignore that the payments were still legally dividends. The law states that in the case of income that can be taxed as both dividends and earnings, it is dividend tax that takes precedence, although the position is not the same for NI.

This difference led the tribunal to rule that both employers’ and employees’ NI was due on the dividends – not a judgment satisfactory to either HMRC or PA, meaning the movement of the dispute to the Upper Tribunal. Its own conclusion barely differed, which eventually left the Court of Appeal to overturn the decision of the tribunal and rule that the dividends counted as earnings from employment, like a salary, meaning that both tax and NI had to be paid on them.

Such disastrous news for PA naturally prompted a further appeal, to the Supreme Court, prior to its abandonment of this plan and acceptance of defeat in May. Although, for a company secretary assisting directors/shareholders taking their income chiefly as dividends, the news may have led  them to expect greater HMRC scrutiny, little actually appears to have changed for other firms as a result of PA’s concession.

There’s little reason to believe that there is much in common between owner-managers using a dividend to extract profit and a contrived scheme, like that of PA, that is solely designed to ensure that employees do not have to pay tax on bonuses by turning them into special shareholders. HMRC would also appear to have recognised this difference, in its confirmation to the Institute of Chartered Accountants’ head tax expert that its victory in its dispute with PA would not result in a change of policy.

Nonetheless, a company secretary catering for directors taking their income mainly as dividends is still advised to ensure that they have all of the proper paperwork to hand for dividend payments. Such a move helps to ensure that if that company does come under investigation, HMRC can’t argue that the dividends really constitute a disguised salary or bonus for the sole purpose of avoiding tax or NI.