Marcus Jays & Anor v The Commissioners for HMRC

By virtue of s384(1) ITTOIA in order for dividends to come within the charge to income tax they must be paid as dividends or have otherwise been made as a distribution in the relevant tax year.

The Appellant accepts that, in accordance with the judgment of High Court in In re Severn and Wye and Severn Bridge Railway Company [1896] 1 Ch 559 (Severn) when a dividend is declared it generally gives rise to an enforceable right to payment. However, by reference to the judgment of the High Court in Potel v Inland Revenue Commissioners (1970) 46 TC 658 (Potel) where the declared dividend is subject to a stipulation as to the terms or time when it is actually paid the charge to tax arises only when that stipulation is removed and the debt in fact becomes enforceable.

By reference to the terms of the undertaking given to Lloyds and the individual terms of the minutes, the Appellant contends that there was no enforceable debt associated with the portions of the declared dividend which were withheld. This, they say, is precisely in accordance with HMRC’s own guidance.

HMRC contend, as accepted by the Tribunal, that the dividends in each year in question were final dividends, recommended by MJ as director of QPL and as voted by the shareholders in the resolution to that effect. As such, they submit, by reference to the judgment in Severn, that an enforceable debt was created in favour of the Appellants on which the Appellants could have sued. They further contend that the crediting of the Appellants’ “director’s blocked accounts” represented payment of the dividend or the making of a distribution in the Appellants’ favour in exactly the same way as the crediting of the more conventional directors’ loan account; as, in each case, the entries recognised a reduction in the distributable reserves of the company and an increase in the assets of each shareholder, who were shown as other creditors in the financial statements.

HMRC drew an analogy to the deposit made by a guarantor. The funds so deposited remain the legal property of the guarantor but act as security for the debt guaranteed. It was contended that the Appellants had simply agreed for the declared dividend to be used by the company to satisfy the cash restrictions imposed by Lloyds and that each of the Appellants, as appropriate, was simply agreeing to not take the cash until QPL could afford for them to do so. HMRC did not consider the terms of the minutes or the undertaking itself represented a legal restriction precluding access to the dividends.

HMRC also did not accept that the terms of the undertaking and the minutes could be assimilated to a statement regarding deferral of payment as considered in Potel.

An unpleaded argument was also raised that, as the Appellants were the joint shareholders of a single share, there was no legal basis on which to declare a dividend payable to one of them but not to the other (recognising that the restriction imposed on KJ’s dividends were, in each year, more significant than those imposed on MJ’s).

HMRC’s position on the writing back of the dividend in 2019 was, in the first instance, that the write back had occurred after the accounts were filed and after the enquiry regarding the dividend payments had begun. HMRC considered that the write back was properly to be treated as a capital contribution by the Appellants.

In Severn dividends had been declared and not paid. When the company went into liquidation the shareholders sought to assert that the dividends were sums held by the company on trust on their behalf. Romer J noted that “the entry in the books of a debtor of a liability to a creditor does not constitute the debtor a trustee” as such, the debt arising was one to which the statute of limitations applied. The determination that the debts were thus unenforceable was predicated on a conclusion that the dividends were enforceable upon declaration. There is no analysis as to the basis of that latter conclusion.

Potel concerned the declaration of interim rather than final dividends. In that case the dividends were declared on the basis that they were payable at a later date. The shareholders sought to avoid a charge to surtax in the tax year 1965/6 on the basis, and by reference to Severn¸ that as the dividends were enforceable from declaration they were not to be treated as forming part of the shareholders’ taxable income in the year of payment. Brightman J summarised the effect of the relevant statutory provisions in that case as: “in the case of a United Kingdom dividend, such dividend forms part of total income of a person for a year of reference … in which the dividend becomes due. The question in issue on this appeal, therefore, is whether the dividends in question ‘became due’ … when the dividends were declared or … when they were paid”.

Brightman J when on to evaluate the issue as follows:

“(1)

… directors who recommend a final dividend have power at the same time to stipulate the date on which such dividend shall be paid: Thairlwall v Great Northern Railway Co. [1010] 2 K.B 509. (2) If a final dividend is declared by a company without any stipulation as to the date for payment, the declaration of the dividend creates an immediate debt: [Severn]; (3) If a final dividend is declared and is expressed as payable at some future date a shareholder has not right to enforce payment until the due date for payment arises. This was assumed to be correct in In re Kidner [1929] 2 Ch. 121, and … it is clear, in my view, beyond doubt.”

He went on to consider that no substantive difference arose between the analysis in respect of final dividends and the interim dividends at point in that case.

Having determined that the declaration of the dividends which were subject to a stipulation for later payment did not give rise to an enforceable debt until the stipulation had expired he went on:

“… I come to the question on which of these [i.e. date of declaration or date stipulated for payment] the dividend became due … There is some guidance as to the meaning of ‘becomes’ due in In re Sebright [1944] Ch. 287. I think it is beyond reasonable argument that a dividend declared in 31^st March and directed to be payable on 29^th May and in fact paid on 29^th May is not in arrear and belatedly paid when the company pays the dividend on the date on which it is expressed to be payable. A dividend cannot be said, in my view, to have ‘become due’ until payment therefore is actually enforceable. If a dividend is expressed to be payable at a future date payment is in my view plainly not enforceable until that date. … Even if I had not formed the view that the payment on 29^th May was an integral part of the resolution … I would still have concluded that the dividends in question were part of the total income of the taxpayer for that year, and for the following reasons. There is a difference between declaring a dividend and paying a dividend. The declaration of a dividend by a company in general meeting creates a debt enforceable immediately or in the future, according to whether the dividend is or is not expressed to be payable at a future date. The payment of the dividend is a different operation. It is an actual distribution of part of the assets of the company. The two processes, declaration and payment, are quite separate.”

In the present appeal the Tribunal is required to determine whether the terms of the minutes declaring each of the affected dividends represents the payment of a dividend or the making of a distribution on the date of declaration.

The judgment of Brightman J is binding on the Tribunal. He was clear that:

The task of this Tribunal is therefore to construe the terms of the minutes and determine whether there is a stipulation as to the date on which the declared dividend is to paid and/or if there is some other stipulation how the Potel judgment is to be applied to the stipulation.

Each minute is set out in full in paragraph 12(8), 12(14), and 12(18) above. The terms of those minutes provided that:

The Tribunal determines that in each case it is clear that the shareholder in question has no immediate right to enforce the identified part of the dividend at the point at which it is declared, and that payment was deferred “until further notice” in the case of all KJ’s dividends and “until mutually agreed” in the case of MJ’s dividend. The deferral in each case was in consequence of the terms of the undertaking given to Lloyds. Those terms, as described by the solicitor, represented a covenant which, if breached would mean that Lloyds would be “within their legal rights to suspend all borrowings and immediately call in the indebtedness. In the worst-case scenario, this would result in a forced sale and foreclosure of the company’s properties.” The terms of that covenant did not legally prevent QPL from declaring any such dividend as was chosen nor did it prevent payment being made of the declared dividend (as a breach of the covenants would not have undermined the legality of the declaration or payment of the dividend). However, acting in the best interests of the company and the shareholders and otherwise in accordance with his fiduciary duties as a director, MJ recommended the declaration of dividends subject to stringent stipulations which, in the view of the Tribunal, had the legal effect of deferring the date on which the stated proportion of the dividends was payable. This conclusion is not, in the Tribunal’s view, precluded because of the absence of a date to which payment is deferred, in each case there was a mechanism by reference to which the date was to be determined (on further notice or as mutually agreed).

It is not therefore necessary to determine how Potel would be applied in the event that the stipulation is not one as to the date on which payment is to be made.

On this basis, and consistently with the judgment in Potel, it is clear that the dividend was not paid for the purposes of section 384(1) ITTIPA.

Neither does the Tribunal consider that a distribution was made. HMRC did not contend that there was a distribution that was not a dividend. However, and in any event, the Tribunal forms the view that, by reference to Potel, the making of a distribution also requires that the recipient has an enforceable right to the assets of the company. For the reasons given neither MJ nor KJ had an enforceable right against the company in respect of the deferred dividends until a time mutually agreed (for MJ) or notice was given (for KJ).

Dealing with HMRC’s unpleaded submission that as there was a single share it was impermissible for QPL to stipulate an unequal deferral. It is to be noted (due to the lateness of the raising of the issue) the bundle did not include the articles of association and HMRC had otherwise pleaded and argued that the dividend had been lawfully declared. As the Appellants rightly submitted, if the dividend had not been declared in accordance either with company law or the constitutional documents of the company there would have been no declaration of a dividend at all and thereby no income within the charge to tax (either in respect of the part paid or the deferred part). In any event, on the basis of Brightman J’s judgment, the Tribunal is of the view there is no legal basis to conclude that a company may not make such stipulation as to the payment of a dividend as it determines appropriate. A shareholder might have an equitable action but would be most unlikely to have a contractual or statute based right of action.

Whilst superficially attractive HMRC’s analogy with a guarantor’s deposit is inapposite. It is not for the Tribunal to analyse the legal and beneficial entitlements which might arise in such a situation. The Tribunal has applied the binding guidance given by the High Court to determination of whether the minutes gave rise to an enforceable debt between the Appellants and QPL as regards the unpaid portion of the dividend and has determined there was no such debt. The accounting treatment of the blocked accounts as other creditors does not affect that conclusion. A bank which makes a loan to a company is a creditor of the company, but the loan capital does not represent an enforceable debt unless and until the company defaults on the terms of the loan.

Having reached the conclusion reached the Tribunal also does not consider it necessary to consider the legal or accounting consequences of the write back of the unpaid portion of the dividends.

For these reasons the Tribunal concludes that:

Were the Tribunal to be wrong in that conclusion it is uncontested that HMRC made a discovery regarding the dividends.

In accordance with the requirements of section 29 TMA HMRC bear the burden of showing that either:

The recent judgment of the Upper Tribunal in Hargreaves v HMRC [2022] UKUT 34 (TCC) has confirmed that the purpose of section 29(5) TMA is “to test the adequacy or otherwise of the taxpayer’s disclosure”. Included within the bundle were the copy entries into MJ’s 2015/16 tax return. It is plain that MJ entered the amount of £64,000 as dividends received by him in that year. There is no entry in what is known as the white space. By reference to the return itself there is nothing to indicate that any disclosure was made by reference to which the hypothetical officer might have been aware that QPL had declared dividends of £206,000 shared equally between the Appellant but in respect of which tax on only £64,000 had been bought into account by MJ.

Mr Gordon manfully sought to argue that by reference to the two prior year tax returns (documents listed in section 29(6) TMA) and/or QPL’s tax return and accounts (documents which Mr Gordon considered were within scope of sections 29(6) and (7) TMA) a hypothetical officer could, potentially, have been reasonably expected to have been aware of the actual insufficiency.

It is a very low threshold for HMRC to show that they could not have been reasonably expected to be aware of the insufficiency. By reference to the analysis in Hargreaves and the cited case the burden on HMRC is a slight misnomer. HMRC will only be precluded from issuing a discovery assessment by reference to section 29(5) TMA where the taxpayer has made a complete disclosure of all the circumstances on which the return has been filed together with the contrasting view HMRC might take of it. Put another way the hurdle of adequacy of disclosure by a taxpayer is extremely high, at the time of filing and/or within the enquiry window the taxpayer will either have provided the disclosure or they will not, there is therefore little for HMRC to prove.

Accordingly, absent any indication in the white space and applying the Hargreaves analysis HMRC would not have been precluded from making a discovery assessment by reference to section 29(5) TMA.

Having reached that conclusion, were there to have been an insufficiency, HMRC would have been entitled to raise a discovery assessment and it is not necessary to consider whether the putative insufficiency was bought about by careless or deliberate conduct. HMRC pleaded both in the alternative.

HMRC presented no evidence of either deliberate or careless behaviour. They made bold assertions in their statement of case, but Ms Johnson’s evidence did not touch on the issue of MJ’s conduct.

Following the ADR it was asserted that HMRC understood MJ to have accepted that his conduct was careless. However, the terms of the exit agreement did not support that conclusion. HMRC had apparently concluded that it was appropriate not to pursue penalties on the basis of deliberate behaviour and to reduce them on the basis of careless behaviour. The Tribunal would not have accepted the terms of the exit agreement or the amendment of the penalty as direct evidence of careless conduct. In the absence of any other evidence HMRC would not have satisfied the burden on them to show deliberate or careless conduct.

However, for these reasons stated, had there been an insufficiency in MJ’s self-assessment, the Tribunal would have considered that HMRC had met the conditions for raising a discovery assessment by reference to the s29(5) TMA condition.

KJ had not rendered tax returns for any of the tax years for which discovery assessments were issued and, as consequence, HMRC do not need to meet the conditions referred to in paragraph [41] above. Thus, provided that HMRC make a discovery of an error and raise the assessment within 4 years of the end of the tax year in question, there is no inhibit on the making of the assessment.

However, pursuant to section 36(1A) TMA, where a loss of (inter alia) income tax attributable to a failure to comply with the obligation to notify under section 7 TMA, HMRC have 20 years in which to raise an assessment to recover that tax.

The discovery assessments issued to KJ were all dated 19 November 2019. As they related to tax years ended 5 April 2014, 2015, and 16 the assessment for 2014 was for a period more than 4 years earlier and, as such, HMRC must establish that KJ had failed to comply with an obligation under section 7 TMA in order for that assessment to be valid.

As far as relevant, section 7 provides at subsection (1) that every person chargeable to income tax shall give notice to HMRC that they are so chargeable. That is unless (under subsections (3) and (6)) in respect of the year in question the person’s total income is from sources from which income tax has been deducted and the person is not liable to tax at a rate other than the basic rate.

KJ’s only source of income is the dividends. On the basis that she was only liable to tax on the dividends paid there was no liability to notify. As identified on the dividend voucher the dividends were paid after deduction of basic rate tax. The dividends paid were all amounts less than the threshold for higher rate income tax. However, on the hypothesis that income tax was due on the full declared dividend KJ was liable to notify. In such circumstances the provisions of section 36(1A) TMA would apply unless, by virtue of section 118(2) TMA, KJ could show that she had a reasonable excuse for the failure to notify.

The test for reasonable excuse is well established in the context of penalties (in respect of which there are a number of statutory exclusions). However, in the recent case of William Archer v HMRC [2022] UKUT 61 (TCC) (Archer) the Upper Tribunal adopted the same general approach to establishing whether a taxpayer has made out a reasonable excuse for section 118(2) TMA purposes as for the penalty regime. In this regard and applying the test as set out in Christine Perrin v HMRC [2018] UKUT 0156 (TCC) the tribunal accepted that when considering reasonable excuse it is necessary to:

The Archer case concerned whether Mr Archer had a reasonable excuse for non-payment of a closure notice in circumstances in which he was challenging whether the closure notice contained a valid assessment. The Upper Tribunal considered that the FTT had acted entirely reasonably in requiring that in order to sustain a contention that he had a reasonable excuse Mr Archer needed to give evidence as to his reasons for non-payment and in particular to establish whether, and if so on what basis, he believed that he was not required to make payment.

In the present appeal KJ’s witness statement included no evidence on the question of reasonable excuse. The position is simply asserted on her behalf in the Appellant’s skeleton argument. For the reasons set out in paragraph [7] above it was inappropriate to permit KJ to give evidence as to the circumstances of her reasonable excuse. Thus, there was simply no evidence before the Tribunal to determine whether she had a reasonable excuse or not. As a consequence, had there been a charge to tax the Tribunal would have upheld the discovery assessments.

Following the ADR the penalties were not an issue to be determined by the Tribunal. As there is no tax due the penalties fall away in any event.

For the reasons stated the appeals are allowed.

This document contains full findings of fact and reasons for the decision. Any party dissatisfied with this decision has a right to apply for permission to appeal against it pursuant to Rule 39 of the Tribunal Procedure (First-tier Tribunal) (Tax Chamber) Rules 2009. The application must be received by this Tribunal not later than 56 days after this decision is sent to that party. The parties are referred to “Guidance to accompany a Decision from the First-tier Tribunal (Tax Chamber)” which accompanies and forms part of this decision notice.