Lee Sharpe looks at dividend waivers and their tax implications.
This article looks at the following topics in respect of dividend waivers:
- what is a dividend waiver, and why they are used?;
- tax issues; and
- how they work and the correct procedure.
What is a dividend waiver?
Simply put, a waiver is where one or more shareholders foregoes or ‘waives’ his or her right to be paid a dividend. Generally, dividends are paid out at a rate of ‘£x per share’ (or x pence per share) and every shareholder is entitled to be paid in accordance with the number of shares held.
A waiver can apply for the next dividend, for a specified period (say, for the next financial year of the company), or even indefinitely – although this last category is not recommended (see below).
Example 1: Dividend not needed
Bill has 50 shares in Wingits Limited. Ben has 25 shares, and Ben’s wife, Bridget, has 25 shares.
The directors, Bill and Bridget, propose to pay a dividend of £500 per share, which means:
Bill receives £25,000
Bridget receives £12,500
Ben receives £12,500
However, Ben does not need the £12,500 and would be happier for the funds to remain in the company. Ben would prefer his dividends be waived.
If he waives his dividend correctly, Ben will receive nothing, but Bill and Bridget will receive their dividends as normal.
Why waive dividends?
In family company scenarios, dividends are usually waived where the shareholder doesn’t want the money – perhaps because they are concerned about paying a lot of tax on the dividend, or perhaps they think the company needs the funds more than they do. Unsurprisingly, HMRC would usually be happier if the dividend were paid.
Tax issues – settlement of income
HMRC will sometimes argue that Ben’s decision to waive his dividend is effectively transferring his income rights to the other shareholders – notably to his wife, Bridget. In particular, HMRC will attack situations where:
- the company does not have the funds to pay all of the dividends on all of the shares unless dividend entitlement is waived by some shareholders; or
- there has been a history of dividend waivers in the past such that, again, the company’s reserves available for dividend distribution would not have been able to fund all of the dividends without some having been waived.
HMRC’s logic is that, if the dividends could not have been paid out unless someone waived their entitlement, the person who gives up his or her right to dividends is effectively ‘giving’ their income to the other shareholders who do take their dividends. In other words, the person waiving has ‘settled’ their income rights on the other shareholders.
Where the settlements anti-avoidance legislation (ITTOIA 2005, s 619 et seq.) is in point, the income that has been settled is treated as being the settlor’s for tax purposes, and the settlor is taxed as if he or she had in fact received the income, rather than having given it away.
Example 2: Is that ‘settled’?
Let us suppose that the company Wingits Ltd in the above example could only have afforded to pay out £37,500 in dividends anyway, so only Ben’s waiver made it possible to pay £500 a share to the remaining shareholders.
Bridget and Ben are married. If she were only a basic rate taxpayer (7.5% on dividends from 2016/17 onwards) but Ben would pay 32.5% on any dividends received as a higher rate taxpayer, it might be understandable for HMRC to argue that Ben has settled some of his dividend income on Bridget, and he should be taxed instead of her – at the higher rate that applies to him in the tax year.
HMRC does not tend to attack non-spouse arrangements, because it is difficult to demonstrate how the settlor might benefit. HMRC is unlikely, therefore, to try to argue that the anti-avoidance legislation should apply to the waiver in favour of Bill.
Note also that the amount of the deemed settlement is the extra amount of dividend that Bridget effectively gets from Ben by his waiving:
Total funds available to make a dividend are £37,500 = £375 per share;
Ben’s original pre-waiver dividend entitlement would be £375 x 25 = £9,375 of which 1/3rd has gone to Bridget (25 out of the 75 shares that did pay) £9,375 x 1/3 = £3,125.
On the basis that HMRC is unlikely to use the settlements anti-avoidance legislation to attack the ‘transfer’ of dividends from Ben to Bill, the amount that HMRC would argue really belongs to Ben is relatively small. More commonly, where the shares are held only by spouses, the adjustments would tend to be relatively larger.
Two quite recent cases involving waivers in favour of spouses are Donovan and McLaren v HMRC [2014] UKFTT 048 (TC), and Buck v HMRC [2008] SPC00716
In both cases, the taxpayers lost; and In both cases, the spouses could not have received the large dividends they did, without waivers having been put in place.
Tax issues – long-term waivers
It is generally not recommended that waivers last for more than twelve months, and they are in practice very rare. This is because a long-term waiver could reduce the value of that shareholding, and even potentially increase the value of those shareholdings that are able to enjoy higher dividends as a result.
This could be deemed to be a transfer of value for inheritance tax purposes (IHTA 1984, s 98), and even ‘value-shifting’ for capital gains tax purposes (TCGA 1992, s 29).
How waivers work
Waivers are usually quite simple documents, stating that the shareholder irrevocably waives his or her entitlement to dividends on specified shares in the stated company, and for how long the waiver will last. The shareholder could specify only a proportion of his or her shareholding to be waived so that he receives some, but not all, of the shares he would otherwise get.
While the dividend waiver is active, any dividends voted will be paid out as normal to non-waived shareholdings, while the waived shares are ignored.
Procedure
- the waiver is a formal deed and must therefore be signed and witnessed;
- it must be executed before the entitlement to any dividend (that the shareholder does not want) arises. The basic principle is that you cannot give away (and avoid tax on) something to which you are already entitled; and
- it should be filed with the company’s statutory records.
Conclusion
Dividend waivers are relatively straightforward devices that can stop dividends being paid. But HMRC can, and will, use the settlements anti-avoidance legislation to treat some of the waived dividend as income ‘belonging’ to the person waiving entitlement, if they can show that he or she still benefited from the money while less tax was paid overall – typically with waivers in favour of spouses who pay tax at lower rates. It is recommended that prospective waivers be discussed with one’s adviser beforehand.
An alternative to waivers is simply to issue different classes of shares, so that different shareholders hold different classes, on which different (or no) dividends are payable. But this does not necessarily prevent HMRC arguing that there has been a settlement if, say, one class/shareholder never receives dividends, and there is no commercial reason why.
Practical Tip:
The best approach is simply to ensure that shareholders have the right proportion of shares in the first place!
