Kevin Read discusses a recent case on payments to a remuneration trust.
It is common for owner-managed business director shareholders to draw a low salary and high dividends when extracting funds from their company. However, what happens when most of those funds are paid into a ‘remuneration trust’ rather than being declared as a dividend?
The case Marlborough DP Limited v HMRC [2021] UKFTT 304 (TC) concerned a scheme designed to extract profits from a dental practice tax-free, while at the same time allowing a corporation tax (CT) deduction for payments to the trust.
The scheme
Dr Thomas traded as a dentist via his company, Marlborough DP Limited [MDP]. The scheme operated broadly as follows:
- MDP established a remuneration trust for the ‘benefit of persons who had provided, or might in the future provide services, custom or products to MDP’.
- The company contributed its entire profits (after other expenses, such as staff salaries) to the trust, deducting these sums as business expenses for both accounting and corporation tax purposes.
- Acting on behalf of the trustee of the trust, a company controlled by Dr Thomas used the funds received from the company to make loans to Dr Thomas.
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Shortly after each contribution was made to the trust, roughly the same amount was paid out to Dr Thomas as a loan.
HMRC regarded the payments to the trust as earnings from employment (or alternatively, as disguised remuneration under ITEPA 2003, Pt 7A), with PAYE and National Insurance contributions due on those payments. It also disallowed the CT deductions claimed.
MDP’s arguments
MDP argued that the contributions and loans were not made as a reward for Dr Thomas’ services as a director. The amounts paid into the trust were determined by seeing how big a payment would be needed to reduce the company’s CT profits to nil. Rather than being earnings, these amounts would have been distributed as dividends if not paid to the trust.
The company appealed the PAYE assessments but accepted that the amounts received by Dr Thomas were in fact taxable as distributions, with no CT deductions being available.
It was also argued that if the tribunal found that the relevant sums were taxable under ITEPA 2003, there should be a deduction for the contributions in computing MDP’s taxable profits.
What did the First-tier Tribunal say?
The First-tier Tribunal (FTT), in adopting a purposive approach to the distribution provisions (ITTOIA 2005, ss 383, 384 and CTA 2010, s 1000), decided that they were broad enough to cover the relevant sums, even though no formal dividends were declared, and the amounts were paid in the form of contributions to a trust, with subsequent loans being made.
There was no contractual obligation on MDP to pay the sums as a reward for Dr Thomas’ services, and nothing to suggest that this was the reason for the extraction of the company’s profits. His extraction policy was essentially no different from an owner of an OMB drawing a low salary and high dividends when extracting funds from their company.
The FTT dismissed HMRC’s disguised remuneration argument. The amounts were not taxable under ITEPA 2003, Pt 7A, as the ‘connection’ test (within s 554A(1)(c)) was not met. His employment was not part of the reason for his receiving the loans.
The FTT also held that if they were incorrect and the contributions were, in fact, earnings rather than distributions, a CT deduction would be available. However, one judge dissented on this point, agreeing with HMRC that no deduction would be available, as the amounts were not incurred wholly and exclusively for the purposes of MDP’s trade.
Practical tip
Subject to any appeal, this case indicates that payments to a remuneration trust can, in some circumstances, be treated as dividends rather than earnings or disguised remuneration.
