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HMRC internal manual

Business Income Manual

Wholly and exclusively: duality of, or non-trade, purpose: remuneration, etc: claim to deduct dividends paid to directors

S34 Income Tax (Trading and Other Income) Act 2005, S54 Corporation Tax Act 2009

Dividends came to directors as shareholders not as remuneration

In the case of Eyres v Finnieston Engineering Co Ltd [1916] 7 TC 74, the company claimed a deduction in respect of dividends paid on shares held by two directors (who were also the controlling shareholders).

The Articles of Association of the company contained a provision that the dividends on shares held by directors were to be regarded as part of the remuneration of the directors. The shares held by the directors had been acquired by them for valuable consideration and were held unconditionally.

The Commissioners’ decision to allow a deduction for the dividends was overturned in the courts.

The Lord President in the Court of Session explained that the dividends came to the directors because they were shareholders and were not remuneration for their services as directors, on page 85:

`…the question really resolves itself into this, whether the right of the Browns (the director shareholders) to receive their dividends was granted to them by way of remuneration for their services. The answer to that question is, of course, that it was not,- that they could not have withheld the dividend from the Browns which was declared on 26th March 1913 - and accordingly I come to the conclusion that these dividends ought not to be deducted from the profits, and they form part of the profits of the year and ought to be assessed accordingly.’

The arrangement seems to have been designed with the intention of converting unearned income (dividends) into earned income (remuneration). Lord Johnston pointed out the difference between money paid to a shareholder for having invested their capital in a company and money paid to a director for having given their services to a company, on page 85:

`My Lord, it seems to me that in this case the Company, or rather the Company’s solicitor, with great astuteness has endeavoured to prove what is impossible. Mr Brown was the owner of the business. Mr. Brown desired to carry it on as a private firm. Mr Brown desired to limit his liability and accordingly he converted it into a private Limited Company. He gets the advantage of that. His liability is limited, but for the future his interest in that Company is the interest of a shareholder as such interests are provided for and defined in the Companies Acts and he cannot by any subterfuge - because after all this is but a subterfuge - avoid paying the price of the limitation of that liability. He must now be treated as a shareholder in the limited Liability Company, and as such his dividends must under the Income Tax Acts be assessed like anybody else’s shares.’