News added on 07.02.2014

from Tax Tribunal LATEST NEWS

Profit Extraction

Dividends waived by husbands deemed taxable on them

In a recent case, a tax tribunal agreed with HMRC that repeated dividend waivers in favour of a spouse should, in fact, be taxable on the spouse making the waiver. Is this the end of dividend waivers?

Facts of the case. Mr Donovan (D) and Mr McLaren (M) each owned 40 ordinary shares (40%) of the company and their wives each owned ten shares (10%). On 6 April 2009 the husbands signed deeds of waiver, waiving their entitlement to dividends for one day; later that day the company declared an interim dividend of £3,200 per ordinary share in respect of the accounting period ended 31 March 2010. Therefore, on that date, the wives received dividends of £32,000 each and the husbands received nothing. Two days later, the wives signed deeds of dividend waiver, waiving their entitlement to dividends for one day; later that day the company declared an interim dividend of £825 per ordinary share in respect of the accounting period ended 31 March 2010. Therefore, on this date, the husbands received dividends of £33,000 each and the wives received nothing. This meant that, for the year ended 31 March 2010, the husbands each received £33,000 in dividends and the wives each received £32,000.

HMRC’s challenge. HMRC carried out a review of the dividend history and found that, since 2001 when the wives became shareholders, there had been a regular pattern of declaring and waiving dividends so that the husbands and wives received roughly equal amounts of dividends, despite the husbands owning four times as many shares as their wives. Therefore, HMRC argued that all these transactions represented an “arrangement”, the effect of which was to take advantage of the wives’ unused basic rate band of tax and avoid the husbands paying higher rate tax on the dividends. In addition, HMRC pointed out that the company had insufficient distributable profits to pay the dividends declared unless the dividend waivers were enacted.

Commercial reason? D and M claimed that the dividend waivers were commercially motivated, to enable the company to retain funds in order to fund the purchase of the company’s own freehold property. But HMRC argued that if the company had wanted to retain reserves it could simply have voted smaller dividends in proportion to actual shareholdings.

Tribunal decision. The First-tier Tribunal found in favour of HMRC that, regardless of the amount of distributable reserves, the purpose of the arrangement was to equalise incomes and reduce tax. Consequently, there was a settlement and the husbands were taxable on their wives’ dividends. However, the tribunal did note that the result of this case does not mean that all dividend waivers should be treated as a settlement for income tax purposes.

Tip 1. Ensure you have a genuine commercial reason for waiving dividends and that there is evidence to support this. This will help avoid HMRC treating it as some sort of bounty or gift out of income and so taxable on the shareholder waiving the dividend.

Tip 2. Make sure the dividend declared per share times the number of shares in issue does not exceed the amount of the company’s distributable reserves.

Tip 3. Don’t use dividend waivers every year as it will be too obvious to HMRC what you are doing. This tax-avoidance tactic should be used selectively.

Providing it’s not a regular occurrence and there’s a genuine commercial reason for waiving a dividend, you should still be able to avoid it being taxable on the shareholder waiving the dividend.

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