Shareholders are obviously liable to pay Income Tax on their dividends, but what if a declared dividend is not – and, in reality, never will be – paid? A tax tribunal pondered that issue in a case concerning an otherwise successful property management company that was saddled with crushing debt servicing costs.

The company was trading well and making good operating profits. Its interest costs in respect of bank loans were, however, so debilitating as to place its business at risk. It was anxious to attract new external equity investors and its sole director took the view that a record of strong dividend declarations would assist in that task.

The company gave a binding undertaking to the bank that it would not make dividend payments to its two shareholders above certain limits. However, with the knowledge of the bank, it formally declared dividends that were well above those limits. The majority of those dividends were never paid, and the relevant funds were instead allocated to inaccessible shareholder accounts with the intention that they would in due course be written back into subsequent company accounts.

HM Revenue and Customs took the view that the shareholders were liable to Income Tax on the declared dividends, as opposed to the much smaller sums that they had actually received. On that basis, back tax demands and late payment penalties, totalling in excess of £60,000, were raised against them.

In upholding their appeal against those demands, the First-tier Tribunal (FTT) noted that the facts of the case were most unusual. It was clear that the shareholders had no immediate right to enforce payment of those parts of the declared dividends that exceeded the agreed limits and that any such payment was deferred until further notice or until mutually agreed.

Had the shareholders been paid dividends beyond the agreed limits, the bank would have been within its rights to suspend all further borrowing and to immediately call in all the company's indebtedness. In the worst-case scenario, that would have led to a forced sale and foreclosure of the company's property portfolio.

The FTT concluded that the dividends which were declared, but retained as unpaid and inaccessible, did not give rise to an enforceable right to receive them as income in the relevant tax years or, in the end, at all. The tax demands were overturned and the penalties thereby fell away.