Tony Granger discusses the impact of waiving dividends, including some important tax issues.
Legal dividends can broadly only be declared from retained profits. For tax purposes, payments made as dividends where there are no profits are usually treated as a loan or salary, and taxed as such.
Waiving your rights to dividends may be perfectly legal under company law, but it is caught by anti-avoidance provisions or the ‘settlement’ rules for tax purposes.
Dividend waivers – points to note
A shareholder can waive his or her right to have a dividend paid to them. The following aspects are important:
- the waiver must be documented before the dividend is declared;
- do not have too many dividend waivers, as these attract HMRC attention;
- the waiver must have a commercial purpose (e.g. retaining more profits in the company for business use); and
- waivers, where one spouse benefits another for tax advantages, are open to attack by HMRC under the income tax ‘settlements’ legislation.
Is that ‘settled’?
Where a dividend waiver is used to divert income to other shareholders, HMRC may challenge the waiver on the basis that it constitutes a settlement for income tax purposes. The dividend received by the other shareholder(s) may be assessed on the shareholder who has waived the dividend.
Not all waivers are caught. An element of ‘bounty’ is needed for the settlement provisions to apply where one or more of the shareholders were to receive a larger dividend than would have been possible had no dividend waiver taken place.
HMRC’s Trusts, Settlements and Estates manual (www.hmrc.gov.uk/manuals/tsemmanual/TSEM4225.htm) provides an indication of the factors that HMRC will consider when determining whether to apply the settlements legislation. Not all dividend waivers are vulnerable to challenge. The following factors would indicate that the settlements legislation is likely to apply:
- the level of retained profits in the company is insufficient to allow the same rate of dividend to be paid on all issued share capital;
- there has been a succession of waivers over several years where the total dividends payable in the absence of the waivers exceed accumulated realised profits;
- evidence which suggests that the same rate would not have been paid on all the issued shares in the absence of the waiver;
- the non-waiving shareholders are persons whom the waiving shareholder can reasonably be regarded as wishing to benefit by the waiver; or
- the non-waiving shareholder would pay less tax on the dividend than the waiving shareholder.
Check the rules
A company can pay dividends according to its own rules, found in the Articles or Table A.
These may include payment at the directors’ discretion or with the written consent of all the shareholders, or of a specified majority of them, or to set up different classes of shares to enable dividends to be paid at different rates.
Make sure that the dividend is legal
There must generally be sufficient profits in the company accounts to make a legal declaration. If you declare a dividend where there are not sufficient retained profits in the accounts to justify it, then the sum could be ‘illegal‘. For tax purposes, it could be treated by HMRC as a director’s loan, or even salary (subject to income tax and National Insurance contributions).
Dividend frequency
Dividends can be paid as frequently or infrequently as the directors see fit, though they must first check to make sure the company has sufficient profit – not cash – to cover the dividend (after corporation tax is paid).
If there is not enough profit in the company to cover the dividend, and the company defaults on its other debts, the unpaid creditors can demand that the dividend be paid back by the shareholders in order to meet their bills.
Summary and key points:
- To avoid illegal dividends, you must be sure that there is sufficient retained profit in the company to cover the dividend declaration. Failure to do so could result in an HMRC investigation, and penalties.
- You will need to keep board meeting minutes, and provide correctly formatted dividend vouchers to all company shareholders.
- Declare dividends for personal tax purposes via the annual self-assessment process. A nominal 10% ‘tax credit’ is applied to dividends in calculating the taxable amount.
- If a dividend is waived - a formal deed of waiver is required, which must be signed, dated, witnessed and lodged with the company.
- The waiver is to be in place before the right to the dividend arises because a waiver after payment is a transfer of income which constitutes a settlement. An interim dividend must be waived before being paid; a final dividend is payable once approved at an AGM, unless confirmed to be payable at a future set date.
- HMRC may investigate whether there is a commercial reason for the waiver. Therefore, best to state in the deed that the waiver has been made to allow the company to retain funds for a specific business purpose.
- Nothing should be given in consideration of the waiver.
- A waiver may cover a single dividend, a series of dividends or dividends declared during a specified period of time.
- Ensure that the dividend declared per share times the number of shares in issue does not exceed the amount of the company’s distributable reserves.
Practical Tip:
Dividend waivers should be used sparingly - avoid waiving every time. HMRC will look more closely at arrangements which are repeated, where the practical effect is to reduce the overall tax payable.
HMRC’s Company Taxation manual includes some helpful guidance on tax and company law aspects of illegal dividends (see CTM20090 and CTM20095).
