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Taxman renews assault on dividends

January 26, 2007

The tax man is launching a ferocious winter offensive against dividend payments, with owner managed businesses in the firing line, warns a specialist adviser.

HM Revenue & Customs is to use the employment securities legislation to levy PAYE tax and national insurance contributions on dividends, traditionally used by owner managers as a tax-efficient way of taking cash out of their businesses.

“This is one further step further down the slippery slope that may ultimately lead to all withdrawals from companies being subject to PAYE tax and national insurance,” says Mervyn MacDonald, head of tax at UK top 30 accountancy and professional services firm DTE.

He fears the latest HMRC move is part of a broader tax assault on shareholding directors of owner managed companies.

“The principal benefit of this sort of dividend payment is that it does not attract national insurance contributions,” comments MacDonald. “However, in December 2006 HMRC published further guidance to its inspectors which I believe could radically alter the situation.”

“The guidance repeats the desire of Treasury ministers to charge PAYE tax and national insurance on ‘the employment reward – the passing of value to an employee in return for the employee’s labour’.”

HMRC will chase PAYE tax and national insurance where it believes:

• special purpose companies are used to disguise cash bonuses as dividends;

• a series of low-value shares are issued to employers who receive a small amount via the pay that is topped up with a dividend;

• ‘composite companies’ are trying to circumvent the IR35 regulations that stop self-employed workers from paying less tax where HMRC believes they are really ‘hidden employees’.

“The guidance makes no reference to owner managed companies, with just one class of shares paying low salaries and high dividends,” says MacDonald.

“However, HMRC’s references to ‘contrived arrangements’, ‘arrangements that are used mainly to disguise cash bonuses’, ‘dividends as benefits’, and ‘thinly disguised general earnings’ lead me to conclude that the low salary/high dividend strategy will soon become an ‘unacceptable arrangement’, potentially subject to attack by HMRC on the grounds that is it in place mainly to generate a PAYE tax and national insurance saving.”

“This is ominous news for the owner managed business sector, which is already struggling under a heavy burden of tax red tape and compliance issues.”