Tribunal confirms that dividends declared but withheld from recipients do not constitute taxable income

In Jays v HMRC [2022] UKFTT 420 (TC), the First-tier Tribunal (FTT) determined that dividends that had been declared, but due to an undertaking, could not be extracted from the company, had not been paid to shareholders for the purposes of their income tax liability.

Background

Mr and Mrs Jays (the Appellants) jointly held the single issued share in Questor Properties Ltd (QP).  Mr Jays was the sole director and Mrs Jays was the company secretary of QP.  In the late 2000s, QP had received a number of loans from a high-street bank in connection with property purchases that it had made.  It also purchased ten interest rate hedging products in connection with these loans, some of which were later accepted by the bank to have been mis-sold.  Others, however, were not, so QP faced both high interest charges and hedges that would have been expensive to break.  QP wished to attract external investors and believed that demonstrating a strong dividend record would make it a more attractive investment.  The bank, however, was unwilling to allow substantial profit to be extracted from the business and the Appellants therefore provided an undertaking to it, agreeing that only certain, specified, dividends would be paid, among them a dividend not exceeding £29,000 to Mrs Jays in respect of the year ending 31 December 2014.

Despite the existence of the undertaking, a dividend of £45,000 was recommended by Mr Jays for that period.  A dividend voucher was provided on 23 December 2014, in respect of the payment of an 'interim dividend' of £29,000.  This sum was credited to Mrs Jays' directors' loan account, and £16,000 was credited to an account named 'directors blocked accounts'.  Equivalent measures were taken in later years, including similar payments to Mr Jays.

Section 383(1), Income Tax (Trading and Other Income) Act 2005 (ITTOIA), provides that "[i]ncome tax is charged on dividends and other distributions of a UK resident company", and section 384(1) that "[t]ax is charged … on the amount or value of dividends paid and other distributions made in the tax year."

HMRC issued discovery and penalty assessments on the basis that the crediting of the 'blocked' accounts constituted payment of the dividends and accordingly the directors had failed to declare these amounts on their relevant tax returns.  It argued that they were final dividends recommended by Mr Jays in his capacity as the director of QP and voted by shareholders to that effect.  As such, HMRC contended that an enforceable debt was created by QP in favour of the Appellants, and that crediting the 'blocked' accounts constituted payment of the dividends or the making of a distribution in the Appellants' favour.  It further argued that there was no basis for declaring a greater dividend to one taxpayer than to the other, given their joint ownership of the share in QP.  The Appellants appealed to the FTT. 

FTT decision

The appeals were allowed.  

The FTT concluded that the taxpayers had no immediate right to enforce the 'blocked' part of the dividends at the point at which they were declared, and that payment had been deferred "until further notice" or "until mutually agreed" for Mrs and Mr Jays' dividends, respectively.  This deferral was a consequence of the undertaking given to the bank, a breach of which would allow the bank to suspend borrowings and call in QP's indebtedness.  On this basis, the FTT concluded that the dividends had not been paid for the purposes of section 384(1), ITTOIA, and therefore that they did not come into charge to income tax.

The FTT further considered that no distribution had been made (although HMRC had not contended that there was a non-dividend distribution), on the ground that the making of a distribution also required that the recipient have an enforceable right to the assets of the company, and this was not the case here. 

Although it was not necessary for the FTT to make a decision in relation to whether HMRC had made a 'discovery' regarding the dividends sufficient to found discovery assessments, pursuant to section 29, Taxes Management Act 1970 (TMA), it noted, obiter, that if there had been an insufficiency in Mr Jays' self-assessment, HMRC would have met the conditions for a discovery assessment.  Mrs Jays had not made returns for the relevant years (as the dividends were her only source of income and basic rate tax had already been deducted from them at source) and so HMRC would, in theory, have had a 20-year period to raise an assessment to recover the tax at stake absent a reasonable excuse for her failure to notify HMRC of the potential tax liability (pursuant to sections 36(1A) and 118(2), TMA).  Since no evidence had been adduced as to reasonable excuse, the FTT noted that it would have upheld the discovery assessments for Mrs Jays.

With regard to penalties, the FTT noted that under the terms of an alternative dispute resolution exit agreement the parties had agreed the basis on which penalties would be imposed, but as the FTT had found that there was no liability to tax, this question fell away in any event.  

Comment

This decision, while made against an unusual factual matrix, contains useful comment on the provisions relating to the taxation of dividends and distributions.  It is also notable for the extent to which the FTT chose to make decisions on obiter points, presumably to obviate the need for a further FTT hearing to find facts on such points in the event that HMRC appeal the FTT's decision (although the decision is not binding, if followed, it could have far-reaching consequences in other cases and it would not therefore be surprising if HMRC sought to appeal the decision).

The decision can be viewed here.