Waived dividends taxable under settlements rules

Waived dividends taxable under settlements rules

Mon 03 Feb 2014

In P Donovan and related appeal (TC03188) the First Tier Tribunal rejected taxpayers’ appeals against HMRC’s determination that dividends paid to their wives should be assessed on them under ITTOIA 2005 s 624 (settlements in which the settlor retains an interest).   

Messrs. Donovan and McLaren each owned 40 ordinary shares (40%) of the company and their wives each owned 10 shares (10%). Since 2001 the company and shareholders had followed 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. The company’s distributable reserves in 2009 were enough to cover the dividends but only because of past waivers.

The taxpayers claimed that there was no settlement because the dividend waivers were commercially motivated, to enable the company to retain funds for future investment in the business, so that there was no ‘element of bounty’.

HMRC argued that:

  • if the company had wanted to retain reserves it could simply have voted smaller dividends in proportion to actual shareholdings;
  • although there was no outright gift of the shares, the dividend waivers, amounted to ‘bounty’. A waiver could never be seen as an arm’s length transaction; and
  • at any time the husbands could have transferred any proportion of the shares to their wives, but chose not to do so.

In this case the settlement to be considered was the dividend waiver. Regardless of the level of distributable reserves, the tribunal found that the purpose of the arrangement was to equalise incomes and reduce tax. That amounted to a gratuitous benefit to the wives which consisted solely of a disposition of income. The judge observed that if the true intention was to enable retention of funds in the company it would have been open to the taxpayers to equalise their shareholdings and pay full dividends without waivers.  Consequently, the husbands were taxable on their wives’ dividends.   Furthermore, HMRC were entitled to make discovery assessments to recover the tax because there was no information in the relevant tax returns in respect of the dividend waivers, the dividends voted or concerning the shareholdings in the company.

This case followed the principles laid down in Garnett v Jones (the “Arctic Systems case”) and that case remains entirely valid. What Donovan does is highlight how narrow the window is through which acceptable “Arctic” arrangements will fit.

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