Patience pays dividends
The First-Tier Tribunal has held that an interim dividend became a debt when it was paid, even though it was paid to a company’s two shareholders at different times. As a result, the two shareholders were treated as receiving their dividend entitlements in different tax years.
- There are two ways for a UK company to pay a dividend: following a declaration by the shareholders (a final dividend) or following a decision by the directors (an interim dividend).
- Different shareholders can agree to receive an interim dividend on different dates. This could be useful for strategically timing payments, including for tax purposes.
- However, the directors can (and, in some scenarios, may be obliged to) revoke an interim dividend at any time before it is paid, potentially leaving a shareholder at risk of non-payment.
What happened?
Gould v HMRC [2022] UKFTT 00431 (TC) concerned a company with (for all practical intents and purposes) two shareholders (who were also brothers). One of those shareholders was resident in the UK. The other had settled in Jamaica, having previously resided for some time in the United States.
In 2015, the company ended up holding cash surplus to its needs. The directors therefore decided to return the cash to the company’s shareholders by paying a dividend.
The rate of UK tax on company dividends was due to change in the 2016/17 tax year. As a result, it was more tax-efficient for the UK-resident shareholder to receive his dividend in the 2015/16 tax year.
The Jamaica-resident shareholder would not normally be liable to pay UK tax. However, due to family circumstances, he had spent more time than usual in the UK during the 2015/16 tax year, creating some doubt over whether he had become tax-resident in the UK. In addition, he had been experiencing difficulties opening a bank account in Jamaica. As a result, it was safer and more tax-efficient for him to receive his dividend in the 2016/17 tax year.
For UK tax purposes, a shareholder “receives” a dividend when the dividend becomes a debt that is due and payable to the shareholder (not when it is actually paid), because this is when the shareholder has an active entitlement to the money. The UK tax year runs from 6 April to 5 April annually.
Company dividends can be paid in one of two ways (see box “The different types of dividend” below).
If the company’s shareholders were to declare a final dividend, they would both “receive” the dividend in the 2015/16 tax year, to the disadvantage of the Jamaica-resident shareholder.
The directors therefore decided to pay an interim dividend and defer payment of the Jamaica-resident shareholders’ entitlement to the 2016/17 tax year. Because an interim dividend does not become a debt until it is actually paid, the idea was that, for tax purposes, the UK-resident shareholder would receive his dividend in 2015/16 and the Jamaica-resident shareholder in 2016/17.
The directors therefore approved the interim dividend on 31 March 2016, paid the UK-resident shareholder his dividend on 5 April 2016 (the last day of the 2015/16 tax year) and paid the Jamaica-resident shareholder his dividend on 16 December 2016 (in the 2016/2017 tax year).
English law essentially recognises two ways in which a company can pay a dividend:
- The directors can recommend a dividend to the company’s shareholders, who then resolve (by passing an ordinary resolution) to declare the dividend. This kind of dividend is often called a final dividend, as it is traditionally paid at the end of a company’s financial year once its profits had been ascertained. However, a company’s shareholders can declare a dividend at any point. If they do so before the company’s financial year-end, the dividend may well be termed a special dividend. We use the term “shareholder-declared dividend”.
- The directors can decide to pay a dividend by passing a resolution among themselves (normally in a board meeting). This kind of dividend is known as an interim dividend, as it is normally paid during the course of a company’s financial year. Directors can pay interim dividends only if the company’s constitution allows them to. Model company constitutions (such as the Model Articles and its predecessor, Table A) permit interim dividends.
A key distinction between these two types of dividend is the point at which the dividend becomes a debt. Once a dividend has become a debt, the directors or company cannot revoke it and the shareholder becomes entitled to enforce payment (e.g. by bringing legal proceedings).
A shareholder-declared dividend becomes a debt at the time specified for payment in the shareholder resolution declaring it. If the resolution doesn’t specify a time for payment, it becomes due immediately. In either case, a shareholder gains a right of enforcement from declaration.
By contrast, an interim dividend does not become a debt until it is actually paid. This is a curious legal concept, as clearly the debt is both created and discharged at the same point in time. However, the purpose of this is to allow the directors to revoke the interim dividend at any point before payment. This might be necessary if (for example) the company’s financial position deteriorates and the company needs the cash to satisfy payments to its creditors.
The flexibility inherent in an interim dividend might make it seem like a more attractive choice generally, particularly for private companies that do not need to adhere to typical traded company dividend timetables. However, there can be good reasons to opt for a shareholder-declared dividend.
- A shareholder-declared dividend creates a debt which the shareholder can then assign on. This may be useful when looking to distribute profits up a chain of companies to the ultimate holding company and beyond.
- Declaring a dividend by shareholder resolution can be useful when remedying unlawful dividends or procedural defects in share buy-backs.
- By declaring a dividend, shareholders can fix a firm and binding date for payment. What is more, the dividend cannot be revoked and so is not susceptible to a change of mind by the directors or a subsequent worsening in the company’s financial state.
HMRC intervenes
HMRC brought proceedings to claim unpaid tax on the Jamaica-resident shareholder’s dividend.
It claimed that, although an interim dividend does not normally become a debt until it is actually paid, in this case, the Jamaica-resident shareholder’s dividend had become a debt when the UK-resident shareholder received his dividend.
This (it claimed) was because the company’s constitution and English common law both required the company to pay dividends equally and proportionately across shares of the same class. In this case, both shareholders held shares of the same class and so should have been paid at the same time.
As a result (HMRC argued), the dividend had become due and payable on 5 April 2016 and the Jamaica-resident shareholder had become entitled to enforce payment or to seek some other remedy entitling him to compensation, such as a petition in unfair prejudice. He therefore received his dividend during the 2015/16 tax year and was liable to pay tax on it.
What did the Tribunal say?
The Tribunal rejected HMRC’s arguments.
It agreed that the company was required to treat both shareholders equally. However, it could find nothing in the company’s constitution (which had adopted Table A) suggesting that a debt arose if an interim dividend was paid to different shareholders at different times.
The Tribunal also acknowledged that a failure to pay an interim dividend to all shareholders at the same time, or to pay the dividend only to selected shareholders, could well give rise to legal remedies for any unpaid shareholders. This might include a petition in unfair prejudice.
However, it was not a foregone conclusion that a court would order monetary compensation (such as payment of the dividend) on a successful unfair prejudice petition. The court has a wide discretion in terms of the order it can make. It is not possible to claim that a debt has arisen merely because a shareholder has a right to challenge selective payment of a dividend.
As a result, the Jamaica-resident shareholder received his dividend, for tax purposes, in the 2016/17 tax year, as intended.
What does this mean for me?
The decision is not surprising but is a useful confirmation of the position on interim dividends.
The fact that an interim dividend does not become a debt until it is paid (and cannot therefore be enforced) can provide useful flexibility for companies. In particular, it can enable the directors (and any willing shareholders) to indicate a plan for distributing company profits but to structure those payments according to a timetable that is convenient (whether for the company, for shareholders or both).
This can cut both ways. In this case, structuring the payment as an interim dividend allowed the shareholders to arrange the payments in a tax-efficient way.
However, a shareholder whose dividend is deferred in this way takes a risk: if the company’s financial position gets worse, the directors may be obliged (in accordance with their duties to the company) to cancel the dividend. In that scenario, the shareholder will not receive the dividend.
In this case, the individual in question was willing to take that risk, but another shareholder may not have such appetite. A company and its shareholders will need to balance various factors, including the amount of time for which the dividend is to be deferred and the company’s trading prospects in the interim. (The latter will be relevant in any event when deciding to pay a dividend.)
Above all, it is important to take legal and tax advice when structuring dividends in this way to ensure they achieve the desired treatment.
