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Dividend disclosures

Z Ltd, a trading company, originally issued 1,000 ordinary shares, one owned by X (father) and 999 by Y (son). About three years ago, 100 B shares were issued to X and Y, 50 each. The B shares have no voting or capital rights other than the return of their paid up capital.

In February 2002, X and Y transferred all the B shares to their wives and since that time numerous dividends have been declared on the B shares. X and Y are higher-rate taxpayers, the wives are not.

The current advisers reported the B share dividends on the wives' tax returns for 2001-02 and 2002-03. X and Y recently received external tax advice that these disclosures may not be correct and they are now confused.

As part of a corporation tax enquiry into Z Ltd, the Revenue requested details of the owners of the B shares, the rights attaching and the dividend history. This information was provided in April 2003. Can readers assist with the following points?

Are the dividend disclosures on the wives' returns correct and if yes, why? (The concern is Tax Bulletins 64 and 69, in particular Examples 1 and 2 in each.)

If the returns are not correct, would X and Y commit an offence under section 144, Finance Act 2000 if they failed to correct the position?

Do the Money Laundering Regulations require a disclosure to the National Criminal Intelligence Service if X and Y do not amend their previous tax returns?

Which tax returns should show any 2003-04 B share dividends and what should be said in the white spaces?

Readers' views are welcomed.

(Query T16,448) — DA.

It seems astonishing that this arrangement was set up some four or five years after the High Court decision in Young v Pearce [1996] STC 743, which was clear authority for the view that it would not work. Perhaps those who set it up could be asked to explain their reasoning by reference to that case.

Unless the B shares have some further rights not mentioned in the query, it seems very hard to defend the arrangement.

The shares given apparently have rights to capital limited to par value and one assumes that substantial dividends have been paid on them. In that event, it is very hard to see why they are not 'wholly or substantially a right to income'. That being so, the dividends are caught by section 660A, Taxes Act 1988 and with the publication of the articles in the Tax Bulletins, the Revenue will clearly expect the past returns to be corrected. This is simple enough in relation to the 2002-03 returns, but the 2001-02 returns are presumably out of time for a taxpayer amendment and a letter will need to be sent to the tax office so that a discovery assessment can be raised. Only if the clients decline to permit this course of action is any report required under money laundering regulations, as clearly the error was inadvertent on their part prior to the advice now being given on the matter.

Similarly, unless there are some convincing arguments, not available from the facts given in the query, to the effect that the B shares are not caught by section 660A, the 2003-04 returns of the clients should be completed on the basis that the dividend income is that of X and Y for tax purposes.

For the future, X and Y should start again with a fresh issue of shares if they wish to have a valid arrangement that will stand up to scrutiny. What should not be done is to add some further rights to the existing B shares or to convert them into other shares with additional rights. Section 660(6) only protects an outright gift if it satisfied the conditions set out in it at the time it was made, and does nothing to help if the gift is subsequently made to satisfy the conditions.

Of course, some guidance on this area may shortly become available from the Special Commissioners, but from what we know of the case involved, it does not apparently involve any argument about section 660A(6) and so it may be of limited interest.

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