Following the First Tier Tribunal Judgement in Marlborough DP Ltd v Revenue and Customs Commissioners  UKFTT 304 (TC), those with Remuneration Trust may be breathing a sigh of relief. The Appellant in that case accepted their motivation was the avoidance of tax although the manner in which funds were extracted were not governed by an intention to incentivise an employee but instead to put the shareholder in funds with the lowest tax cost possible.
The FTT transcript sets out the legislation which imposes a charge to income tax on “dividends and other distributions of a UK resident company” by reference to amount or value of the dividends paid and other distributions made in the tax year. Section 1000 CTA 2010 provides the meaning of “distribution”, which includes:
(3) For the purposes of this Part a thing is regarded as done in respect of a share if it is done to a person –
(a) as the holder of the share, or
(b) as the person who held the share at a particular time.
(4) For the purposes of this Part a thing is also regarded as done in respect of a share if it is done in pursuance of a right granted, or an offer made, in respect of a share.
The FTT found that “Having regard to the natural meaning of the terms used in s 1000 CTA 2010 (as further explained in s 1113) and viewing those provisions in the overall context of Part 23 CTA 2010, it appears that the purpose of ss 383 to 385 ITTOIA as regards distributions is, in broad terms, to tax a shareholder on any value which a company delivers out of its assets into a shareholder’s hands by some non-prescribed means (whether directly or indirectly) as a return on his shareholding except where one of the specified exemptions apply”
A distribution is in respect of shares in the company where the relevant asset or value is put into the hands of a shareholder in his capacity as shareholder.
Hoffmann J said in Aveling Barford Ltd v Perion Ltd :
“Whether or not the transaction is a distribution to shareholders does not depend exclusively on what the parties choose to call it. The court looks at the substance rather than the outward appearance.”
Pennycuick J stated in Ridge Securities Ltd v IRC , which concerned an artificial tax-avoidance scheme:
“A company can only lawfully deal with its assets in furtherance of its objects. The corporators may take assets out of the company by way of dividend, or, with the leave of the court, by way of reduction of capital, or in a winding-up. They may of course acquire them for full consideration. They cannot take assets out of the company by way of voluntary distribution, however described, and if they attempt to do so, the distribution is ultra vires the company.”
HMRC mentioned another case to the FTT: Re Implement Consulting Ltd (in liquidation); Toone and others v Ross and another –  STC 382. In that case, the respondents were directors of a company who sought advice in relation to an employee benefit trust (‘EBT’) and an interest in possession (‘IIP’) trust. The company paid funds into the EBT and the IIP. HMRC notified the company it was enquiring into the schemes and subsequently issued an assessment and offered to discuss settlement terms. A further substantial payment was made by the company to a shareholder and employee as expenses. The company entered voluntary liquidation with HMRC as its main creditor. The applicant liquidators claimed that the payments made by the respondents to the EBTs and the IIP had amounted to distributions of the company’s assets made in breach of trust and/or fiduciary duty and/or were unlawful and void within the meaning of section 423 of the Insolvency Act 1986. It was also contended that the payment to the shareholder for expenses had been made by the company when it had been insolvent or near insolvency because of the company’s debt to HMRC. The respondents submitted that the payments to the EBTs and the IIP were made at a time when the company was solvent and were made following professional advice.
It was held that the purpose of the EBTs had been to withdraw an asset out of the company and not pay tax. Whilst an offshore trust was the chosen tool the end recipients had been and had always been intended to be the shareholders. The EBTs acted as a conduit through which the shareholders, who had also been directors and/or employees of the company, had been given a tax-free sum taken from the company’s capital. The payments to the EBTs and the IIP had not been transactions reasonably incidental to the carrying on of the company’s business. The payments had not been done for the benefit and to promote the prosperity of the company. Accordingly, looking through the eyes of the company, the payments were to be characterised as returns of capital to shareholders. The returns of capital had been unlawful.
In such situations, the director is likely to have acted in breach of their statutory duties under the Companies Act 2006 (for example, failing to promote the success of the company for its shareholders). They may also be guilty of misfeasance under Section 212 Insolvency Act 1986. A director is therefore at risk of a claim for damages and/or to repay or restore the funds amounting to the losses they caused to the company, plus interest, as a result of the dividend payment. A director may also find themselves subject to disqualification proceedings by the Secretary of State.
The argument put forward by HMRC that payments through a remuneration trust were emoluments and the FTT’s deliberations that such payments may be unlawful distributions creates a bit of a Catch 22. In Joseph Heller’s Catch 22, a prostitute wearing green lime pants is thrown to her death rather than the thrower accepting he had use of her services. Rather extreme but will some users of the remuneration trust need to consider exposing amounts received as earnings and subject to PAYE or avoiding such an argument and contending they were motivated by their shareholding and being at risk of challenges under the Companies Act and/or the Insolvency Act. A catch 22….
Probably annoyingly for HMRC, each case (and there are a lot of them) would need to be looked at in isolation. Maybe this is why, since HMRC has been intent on pursuing, a change in legislation may have been easier.