Under company law, dividends paid on shares must be the same for every share of the same class – indeed, dividends are commonly expressed as being ‘£x per share’. For example, if I have 60 of the company’s 100 £1 ordinary shares, and you have the other 40, and the company pays a dividend of £1,000, that is £10 per share and I will get £600 while you get £400.
In the case of a family company, this may not be what the shareholders want to achieve. For example, one may be paying income tax at 40%, while his spouse is a basic rate taxpayer. After taking account of the tax credit that comes with a dividend, a 40% taxpayer ends up paying income tax at a rate of 25% on dividends paid to him, whereas a basic rate taxpayer has no additional tax liability.
In other cases, one shareholder may have a particular expense to meet – say, a new car – and would like a larger dividend than their shares entitle them to.
There are two ways to achieve this: dividend waivers and ‘alphabet’ shares.
Dividend waivers
A shareholder can execute (lawyerspeak for sign) a formal document waiving his right to a dividend, meaning that there are potentially more profits to be paid out as dividends to the other shareholders. Typically, this is done just before the dividend concerned is due to be paid, and it is important to get the timing and the formalities right, but that is not the point of this article.
The risk with a dividend waiver is that HMRC can challenge it as a ‘settlement’, which means an arrangement whereby the potential to receive income is transferred from one individual to another. Where a settlement benefits a spouse or minor child, the income concerned can still be taxed on the ‘settlor’ – the shareholder who waived the dividend. HMRC can also attack in other circumstances, though there is considerable legal disagreement about how far such a challenge can go.
The point about dividend waivers is that HMRC are highly suspicious of them, and are likely to look very closely at what has gone on to see if they can attack it in any way.
‘Alphabet’ shares
This involves each shareholder having a different class of shares – for example, father has 35 ‘A’ ordinary £1 shares, mother has 35 ‘B’ ordinary £1 shares, and daughter has 30 ‘C’ ordinary £1 shares.
When it comes to distributing the company’s profits, separate dividends of different amounts per share can be declared for each class of share, so a dividend of £10 per share (or nil per share, but this is perhaps a bit provocative) can be declared on father’s A shares (he’s the 40% taxpayer), £1,000 per share on mother’s B shares (she has no other income), and £500 per share on daughter’s C shares (she wants a car).
It is much harder for HMRC to challenge this arrangement, because there is clear case law (the famous ‘Arctic Systems’ case) that says that this is not caught by the ‘settlements’ legislation, and I have only ever seen it challenged in extreme cases involving highly paid executives whose large bonuses were paid using alphabet shares in a company set up for the purpose.
Practical Tip :
If you want the ability to vary the dividends paid to each shareholder, alphabet shares are much simpler than dividend waivers, and much less likely to be challenged by HMRC.
