Synopsis: Dividend payments are used by many owner/directors as a means of drawing profits from a company with no liability to National Insurance contributions (NICs) and a reduction in income tax. The case of PA Holdings Limited examined the scope for HMRC to re categorise dividends as remuneration for income tax/NIC purposes.

Date posted: Monday, December 16, 2013

It is common practice for director/shareholders of close companies to draw a part of their remuneration from the company by way of dividends rather than salary/bonus.

The payment of a dividend

– avoids NICs, and

– means that, to the extent the grossed-up dividend falls within the shareholder’s basic rate tax band, it will not suffer further income tax in the shareholder’s hands.

Dividends that cause the shareholder to exceed the higher rate tax threshold will suffer income tax at 32.5% and those which cause the additional rate threshold of £150,000 to be exceeded will suffer income tax at 37.5%. In calculating tax due account can be taken of the 10% tax credit.

In contrast, earnings that exceed these tax thresholds will suffer income tax at 40% and, if above the additional rate threshold, 45%. NICs will be payable in addition.

Many proprietors of close companies therefore pay themselves a fairly low salary – to qualify for State social security benefits – and top this up with a dividend payment.

However, there was concern that the tax efficiency of this type of planning might be under threat following the case of PA Holdings (PA) v HMRC.

PA used a scheme which had the intention of avoiding NICs on bonuses that PA paid to its employees.

This was achieved by issuing a special class of share which the employees bought for a nominal price. Large dividends were then paid on these shares. HMRC challenged the scheme and this lead to speculation that there may be a more general attack on directors of owner/director companies who also take most of their income as dividends.

The First-tier Tax Tribunal ruled that the dividends paid in this case were really a disguised bonus. On the other hand the Tribunal concluded that it is not possible to ignore the fact that, legally, the payments remained dividends. In this situation dividend taxation takes priority and so the payment could not also be taxed as earnings. However the position for NICs is different and here the Tribunal ruled that both employers’ and employees’ NICs were due on the dividends. On appeal the Upper Tribunal reached the same conclusion.

A further appeal was then made to the Court of Appeal who overturned the Tribunal’s decision and ruled that the dividends counted as earnings from employment (i.e. in a similar way to salary). Because of this they should be subject to both tax and NICs accordingly.

PA appealed to the Supreme Court, but it then abandoned its appeal and accepted defeat. This renewed fears of an HMRC attack on substantial dividends paid to owner/directors.

There is, of course, a considerable difference between a scheme designed to give employees a right to a specific class of shares solely to avoid tax on a bonus and owner/directors extracting profit by way of a dividend. Fortunately, it seems that HMRC is taking the same approach and it has been reported that it will not be changing its policy as a result of winning its dispute with PA.


The outcome means that a small salary plus large dividend strategy is still a safe tax and NI-saving arrangement for company owner/directors. Therefore, there is no need to change the approach as a result of the PA case. However, owner/directors should be wary of using more esoteric schemes as a way of paying dividends – particularly to employees – as these are liable to be attacked.

Owner/directors should also ensure that they have the proper paperwork in place for dividend payments. This will ensure HMRC cannot successfully argue that there has been a disguised payment of salary or a bonus as a dividend merely to avoid income tax and/or NICs.

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