Salary or dividends case

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Husband and wife directors win employment tax appeal say Harris & Co accountants Northampton, the specialist small bsuiness accountants

A husband and wife who ran a recruitment business and were paid mainly through dividends before its collapse do not owe HMRC employment taxes after they reclassified the dividends as salary, the First Tier Tribunal (FTT) has ruled.

The case concerned Richard and Julie Jones, who were directors and shareholders of a recruitment consultancy company, Perfect Change Ltd, which was set up in 2003 and collapsed in 2009. [Richard Jones, Julie Jones v Commissioners for HMRC, TC04171, Appeal TC/2013/00627 & TC/2013/00630].

For tax efficiency purposes, Mr and Mrs Jones received income through interim and final dividends, combined with modest monthly payments of directors fees.

The directors fees were £450 per month so that very little or no PAYE or national insurance contributions (NICs) were payable. There were three or four other employees and PAYE and NICs were deducted and paid from their wages.

In January 2009, the company’s credit facility was withdrawn and in February 2009 it went into insolvent liquidation.

As part of the preparation for the liquidation, the Jones were advised to reclassify the interim dividends as salary.

Following the insolvency, HMRC investigated and concluded that there had been a wilful failure to deduct tax and NICs from the Jones’ emoluments in 2007–08 and 2008–09 and that they knew about that failure.

The couple said that payments to them by the company were dividends rather than emoluments and that there was no obligation to operate PAYE and NICs.

The annual accounts for year ended 31 March 2007 showed directors’ salaries of £10,800 and dividends of £139,000. The first set of draft accounts for year ended 31 March 2008 which had been produced by 9 May 2008 showed directors’ salaries of £10,800 and an interim dividend of £138,100.

In the latter half of 2008 they reduced the level of dividends by 50%. In the period 26 August 2008 to 22 December 2008 they received dividends of £22,000, whereas in the same period in 2007 they had received dividends of £56,950.

Mr Jones’ tax return for 2007-08 was submitted in January 2009. It showed salary of £5,400 and dividends of £29,250. For Mrs Jones, the figures were £5,400 and £15,750 respectively.

In January 2010, Mr Jones submitted his tax return for 2008-09. It recorded dividends as nil, salary from the company of £226,010 and tax taken off amounting to £83,206. 

The FTT said he had been ‘ill-advised’ to include these figures  on his tax return, ‘but we do not consider that he was deliberately seeking to deceive HMRC". For the same period, Mrs Jones returned dividends as nil, salary of £133,276 and tax deducted from salary of £45,528. Both obtained a small tax repayment.

The reclassification of dividends in preparation for the liquidation of the company ‘did not truly reflect the nature of the payments at the time they were made’ and the directors could not retrospectively alter the nature of the payments by simply deciding to treat them differently, the tribunal ruled.

The judgment stated: ‘On the basis that the dividends were lawfully paid, the so-called reclassification... would have no effect.’

They could not transform what had previously been received as dividends into salary unless there had been some error or misunderstanding at the time of payment and there had been no such error or misunderstanding.

The FTT therefore allowed the appeal, set aside the PAYE direction notice and set aside the decision to make the Jones liable for NICs. It made a distinction between this case and the case of Williams [2012] TC 01988, in which the FTT dismissed the appellant"s appeal against a direction notice under SI 2003/2682, reg 72.

CCH tax specialist Meg Wilson said: ‘Although many of the facts were similar, in that case [Williams] the appellant was aware that dividends could not lawfully be paid at the time he took sums from the company, the sums were therefore treated as drawings and debited to a loan account, causing it to become overdrawn. The company planned to vote a dividend to clear the loan account, but was never able to do this because it did not have sufficient distributable reserves.

‘The company decided to treat Williams as having received sufficient net salary to clear the overdrawn loan account in the knowledge that the company would not pay the PAYE and NICs. In the Jones case  the dividends had been lawful, but if they had not the position would have been different.’  

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