HMRC have won their appeal to the Court of Appeal in HMRC v PA Holdings Ltd [2011] EWCA Civ 1414.

Summary

The judgement, delivered by Lord Justice Moses (with which Maurice Kay L J and Lady Justice Arden agreed) held that dividends paid on forfeitable shares, in a specially formed company, acquired by employees of PA Holdings are properly taxable as earnings – subject to income tax and NICs – and not as dividend income.

This represents another victory for HMRC in it’s “war on tax avoidance” particularly in relation to the payment of bonuses. Appeals to the Upper Tribunal in the UBS and Deutsche Bank cases are due for hearing in early 2012. These relate to arrangements intended to comply with specific statutory exemptions in relation to restricted employment-related securities. With a victory in the PA Holdings case under their belt, HMRC might feel the judicial tide is turning in its favour.

Analysis

Section 20(2) (now superseded) provided that “no distribution which is chargeable under Schedule F shall be chargeable under any provision of the Income Tax Acts”. The First and Upper Tier Tribunals had held that the income was both earnings (within Schedule E) and a distribution (per s209 ICTA 1988), and that, by virtue of s 20(2), it was chargeable under Schedule F and not Schedule E.

The Court of Appeal held that the Schedules, in ss15-20 ICTA, were mutually exclusive (per Salisbury House Estate Ltd. v Fry (1930 AC 432). As, viewed realistically, the income in this case was properly to be treated as earnings, it fell to be taxed only under Schedule E, and not under Schedule F. Income falls to be taxed either under the one or the other. Section 20(2) has no application to a payment chargeable under Schedule E. It merely resolves the conflict where income from one and the same source, being shares or certain securities, is charged under different schedules. For example, if an investment company holds shares as dealing stock, and receives dividends on such shares, such income may fall within the residual Schedule D, Case III or Case VI. However, as they would also fall within the charge under s20(1), s20(2) provides that they must be taxed under Schedule F. Section 20(2) is concerned with income from one source, shares, which in the absence of s 20(2) could be charged under two different Schedules. Schedule F does not take priority over Schedule E. It does not charge emoluments at all. In this case, the income never came within s20.

It was not necessary to adopt a “Ramsey” approach in determining that the income fell to be taxed as earnings from the employment, although, having regard to the need to apply a purposive construction to the legislation, it was clear that the insertion of the steps which created the form of dividends or distributions did not deprive the payments to employees of PA Holdings of their character as emoluments. The award of the shares and declaration of the dividend were the process for delivery of what was a bonus.

The Court did recognise that there can be circumstances in which employees may be awarded shares as an incentive or reward and that those employees may subsequently receive dividends or distributions in respect of their shareholding, the source of which is the shares, not the employment. The question is: are the income receipts of the employee emoluments or profits from employment ? In answering this, the court must identify the character of the receipt by looking at its substance, and not its form. The cases of White v Franklin (165 1 WLR 492) and Brumby v Milner (1976 51 TC 583) are examples of circumstances in which the receipts have been characterised as emoluments. By contrast, in Abbot v Philbin (1961 AC 352), the profit accrued to the employee as holder of, and was derived from, the share option and not from employment .