In Richard and Julie Jones v HMRC  TC04171, the First Tier Tribunal (FTT) decided that interim dividends, once lawfully declared, could not be reclassified as remuneration subject to Pay As You Earn (PAYE) prior to the insolvent liquidation of a company.
- The taxpayer’s recruitment company went into insolvent liquidation in February 2009.
- The taxpayers had received modest remuneration and interim dividend payments, which were based on monthly management reports.
- Their accountant advised that the interim dividends should be reclassified as salary payments. This was an attempt to avoid the possibility of the liquidator reclaiming the sums on the basis that they were unlawful dividends.
HMRC sought to recover the PAYE and National Insurance (NI) under Regulation 72(4) from the taxpayers personally on the basis that they knew at the time the payments were reclassified as salary and that the employer had wilfully failed to deduct tax.
The Tribunal found that the reclassification that occurred did not truly reflect the nature of the payments at the time they were made. The directors could not retrospectively alter the nature of the payments simply by deciding to treat them differently. The payments were clearly made as interim dividends and taxable as such, rather than as salary.
On the basis that the dividends were lawfully paid, the reclassification had no effect and the taxpayer no liability to the company. The taxpayers' appeal was allowed.
The case confirms the position. You cannot re-write history (much as both advisers and HMRC seem to try to from time to time). If a dividend has been properly voted it cannot be reclassified.
It is worth pointing out that had the board failed to observe the formalities of declaring dividends correctly, the liquidator could have declared them to be unlawful and sought repayment on behalf the company. If that were the case the payments would still not be transformed into earnings, they would amount to loans made to the directors.
Legal or unlawful dividends: Companies Act 2006
Summary the requirements of the Companies Act 2006 to be followed on paying dividends
Unlawful or illegal dividends: Tax
A guide summarising the different tax charges depending on outcomes following an illegal dividend
Dividends: Formalities for companies
A briefing and overview for discussion with directors
Dividends (how to pay and process): Step-by-step guide
A step-by-step guide for companies and their owners.
See also our Directors' loan accounts: Toolkit and Close companies: Tax planning and pitfalls for details of the section 455 tax charge and way that Chapter 6, Part 4 ITTOIA 2005 treats certain benefits and expenses to participators as dividends.