Don’t fall foul of HMRC’s dividends sweep

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Whether or not your client has undeclared dividend income to report, documentary evidence is vital.

There’s been a buzz recently about HMRC sending letters to thousands of taxpayers to inform them that they may have undeclared dividend income to report.

HMRC uses a system called HMRC Connect that is able to scan, read and collect data from an ever-growing list of sources. “They’ve got access to bank records, various tax information exchange agreements, savings, pensions, investments, land registry, Zoopla, and they have also recently added Companies House,” explains Lisa McPherson, Head of Tax Technical at PKF Francis Clark.

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Casting the net wide pays dividends

Connect now automatically collates information from more than 30 databases, even up to activity on online platforms such as eBay and Airbnb, to check whether someone is trading or hiring out property without declaring it. This collation is an increasingly common tactic in HMRC’s ‘nudge’ led anti-evasion efforts, which involves HMRC Connect triggering an alert and sending a nudge letter to a large number of recipients that might be in breach of a particular rule.

“So they’re scraping all this together, and if anything throws up flags, it notes it,” says McPherson, who explains that typically, a nudge campaign will see letters go out to 2,000 people, 1,900 of whom will have nothing to declare.

“But for the 100 that have missed something off their return, they can then make a disclosure, meaning the revenue gets the tax, some interest, and possibly some penalties. And they get that all for the investment in time to administer it, as opposed to opening inquiries into 2,000 people and finding out that 1,900 have nothing to declare.”

It’s this process that has driven the recent wave of letters focusing on dividends. But McPherson is at pains to point out that even if a taxpayer or accountant receives such a notice, it does not mean that they haven’t declared all the necessary dividends, and that there may be a number of innocent reasons for the flag in HMRC’s systems.

“These letters are a cheap cash-raising exercise for HMRC though, and if it gets a small positive ‘hit-rate’, it more than pays for the administrative costs of running the exercise,” McPherson says.

Communicate with HMRC

So in this latest wave, HMRC is comparing consecutive sets of accounts, to select companies that have made profits but appear to have depleted reserves, potentially flagging up that a payment of a dividend or distribution has been made to that company’s shareholders.

In terms of a response where accountants deal with the company accounts, and possibly also Company Secretarial matters for the client, they should have access to the information and it is a case of ensuring communication between departments.

“If we are not engaged to deal with accounts and/or Company Secretarial (including dividend vouchers, Board Minutes, etc) then the question is asked on the annual tax return questionnaire sent out in early April every year,” says McPherson. She notes that there will be situations where dividends are voted, but not – for whatever reason – taken (they may be waived, or circumstances may change – e.g. unexpected liabilities later in the year which means that there are insufficient reserves to pay an interim dividend).

It is also important to make sure that evidence is available to show a dividend being properly voted and paid. Because directors have a fiduciary obligation to ensure dividends are legal and valid, documentation is required to demonstrate that the correct procedure has been carried out, to affirm that dividends have been correctly processed and to show evidence that dividends were intended – this may also include evidence that the client follows a pattern of taking such dividends.

A proactive approach you can take

So be warned: without the proper documentary evidence, HMRC may argue that payments were not dividends but are instead loans or employment income, subject to IT/NIC/s.455 tax. Therefore they will expect to see evidence both of payment and of the decision to make that payment.

It is worth noting that a dividend is legally a payment per share and so dividends must be in proportion to shareholdings. The usual process is to establish the distributable reserves, then establish the dividend per share used to calculate total dividend payment (not the other way around!)

If a shareholder intends to waive their dividend, there must be sufficient reserves that the waived dividend could legally have been paid.

McPherson has a number of suggested steps that accountants should follow to avoid falling foul of the dividend sweep:

  • Consider dividend payments for a year before the end of the tax year.
    • This avoids the problem of lack of evidence as to when they were voted.
    • February is an excellent time of year to conduct such reviews for all clients.
  • Consider pre-year-end reviews in any case – they are good practice.
  • Ensure proper documentation is in place for each dividend.
  • Ensure the dividend has been properly declared in accordance with the Companies Act formalities and the company’s Articles of Association.
  • This should make it easy to challenge HMRC should it seek to treat the payment as employment income.
  • Communicate to clients the importance of correct documentation, where they are dealing with their own Company Secretarial work.
  • There must be absolutely no ‘retrospective’ dividends or ‘back-dating’ of documentation – either of these may amount to fraud.

‘Nudge’ campaigns are the future

As a final note, it’s clear that HMRC’s ‘nudge’ campaigns are here to stay. Since 2019, letters have gone out regarding offshore assets (which might be subject to IHT, or be sources of future income or gains) as well as offshore income and gains – these arise from the UK’s tax information exchange agreements negotiated by the government and also the common reporting standard.

“Similarly, we have had letters asking about residential property sales arising from HMRC’s access to HM Land Registry records, claims for the plant & machinery super-deduction, R&D claims, undeclared income from short-term property letting (Airbnb etc) and claims for repairs & renewals against rental costs, and potential breaches of the £1m BADR lifetime limit,” says McPherson.

She also counsels accountants to take a proactive – and preventative – approach to this. “Ultimately, you don’t want clients in this situation. It’s understandable that if we’re not involved, we have to rely on the client telling us what they’ve done. And clients can forget things, or they can forget they’ve done something. Or they’re businesspeople and they’re busy. They’ve got a million and one to worry about, and they do get things wrong.

“So we just have to hold their hand and help them through the disclosure. That means saying to HMRC, ‘This is what happened, here’s the tax’. But actually, if we’re doing all the work, then yes, why shouldn’t we be proactive and talk to them about their dividend policy and make sure we’re on top of it all.”

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Christian Doherty is a business journalist and freelance writer for AAT.

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