Remuneration or Dividends - Recent Developments

04 March 2005

It is possible to extract cash or value from a company in several ways including remuneration, bonuses or dividends. There have been a number of opportunities for structuring the extraction in a tax-efficient manner, especially for high rate taxpayers, and employee/manager equity participation has become heavily structured in some private equity deals.

At the level of smaller companies, tax and National Insurance Contributions ("NICs") will be saved if the right mix of equity participation and remuneration for owner/manager/employees can be found. However, the government has recently expressed concern at the amount of income tax and NICs being lost because of these schemes.

During the last two years in particular we have seen important changes to the underlying tax legislation for employee share schemes and the Inland Revenue's approach to remuneration planning. In relation to the former we have Schedule 22 of the Finance Act 2003 which introduced a new regime for taxing non-Inland Revenue approved share 'schemes'. An example of the latter is where the Revenue have in recent years begun to rely on provisions in the Income and Corporation Taxes Act 1988 (section 660A) in deeming dividends paid to co-owners (usually the spouse or other family member) as income and taxing it accordingly in certain circumstances.

The basic approach of the government in this area is that only genuine investment gains by employees on shares in their employing company which were made on arm's length terms should be taxed as capital rather than income.

On 2nd December 2004, an announcement was made in the pre-budget report ("PBR") which may effectively end aggressive tax planning in this area or at least give schemes a limited shelf life. In the report, and the accompanying statement from the Paymaster General, the point was made that certain disclosure rules had resulted in the government becoming acutely aware of the nature of the problem.

Disclosure Rules
 

In addition to substantive (largely anti-avoidance) amendments to the taxation of unapproved share schemes, Schedule 22 of the Finance Act 2003 contained a controversial administrative shock. If shares or other 'securities' are issued to a person by reason of their employment then this is a reportable event and must be notified to the Revenue on Form 42. This must be filed by 6th January following the end of the tax year in which the reportable event took place. Failure to comply with this duty carries a penalty of £300 and the possibility of a further penalty of £60 per day until the form is filed.

The problem with Form 42 notification is that the net of a "reportable event" is widely cast. It occurs when an individual has acquired shares by reason of a current, former or prospective employment or directorship. The Revenue has commented that shares subscribed for or subscriber shares acquired during the formation of a company do indeed constitute reportable events. Given the punitive nature of the reporting regime, it may be advisable to disclose if there is any doubt.

A more widely reported disclosure duty was introduced by the Finance Act 2004 and requires promoters and, potentially, users of certain tax planning arrangements (or even proposed arrangements) in relation to employment to disclose details of those arrangements to the Revenue.

It should be remembered that tax planning is and remains lawful but it is clear that the Revenue are very keen to find out about both employee ownership of shares and the details of any innovative tax planning schemes at an early opportunity.

The Future
 

It is reasonable to ask what the Revenue will be doing with this information and it is clear from the Paymaster General's statement that they do not intend to drag their feet. The statement makes it plain that to the extent that legislation may still not achieve its objective in the face of continuing avoidance, the government will ensure that it does.

The statement goes on to declare that where any remuneration planning takes place after 2nd December 2004, the government reserves the right to introduce retrospective legislation to counteract it from that date. The statement concludes:

"I am therefore giving notice of our intention to deal with any arrangements that emerge in future designed to frustrate our intention that employers and employees should pay the proper amount of tax and NICs on the rewards of employment. Where we become aware of arrangements which attempt to frustrate this intention we will introduce legislation to close them down, where necessary from today."

Small companies, the self employed and the tax system
Whilst the Paymaster General's statement specifically makes reference to City bonuses, and the tax planning disclosure regime appears to be a swipe at certain highly structured private equity arrangements, any resulting legislation or policy will be of general application.

It is interesting to note that HM Treasury also took the opportunity of the publication of the PBR to publish 'Small companies, the self-employed and the tax system: a discussion paper'. It aims to open up a discussion on strategic issues relating to the taxation of small companies and the self-employed. Apparently, "Issues raised in the post-PBR discussion with interested parties will inform government thinking on the strategic development of the personal and corporation tax regimes as they relate to small businesses". Against the background of the 'settlements' provisions of Section 660A referred to above and the IR35 regime, some clarity is perhaps called for but given the general tone of the Paymaster General's statement, this clarity, if achieved, may not be entirely good news for owner/managers of such companies.

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