When a private limited company is incorporated, it is usual for the issued shares to be ordinary shares divided in equal proportions amongst the subscribers (invariably those shareholders are also the directors). In time, this proportional allocation may result in dividends being paid to a shareholder who does not need the money, or who would have to pay higher rate tax on them.
Should a shareholder not wish to receive the dividend, he may voluntarily ‘waive’ (i.e. give up entitlement to) the payment, such that he does not receive payment but the remaining shareholders still do. The company’s distributable profits are then divided between the remaining shareholders in the proportion of their holdings. Dividend waivers can thus be an effective tool in tax planning, but only if used correctly and with care, ensuring that the legalities are complied with.
Will HMRC become interested?
An arrangement that frequently attracts HMRC’s interest is where each spouse owns shares in a family owned company, but one spouse ‘waives’ their right to income. HMRC’s argument is that the waiver indirectly provides funds for a ‘settlement’ on the receiving spouse. The ‘settlement’ legislation is to be found in ITTOIA 2005, Pt 5, Ch 5. A ‘settlement’ is defined widely as being ‘any disposition, trust, covenant, agreement, arrangement or transfer of assets’.
Paragraph 4225 of the HMRC’s Trusts Settlements & Estates manual provides an indication of the factors that HMRC will consider when determining whether to apply the settlements legislation as follows:
- There is evidence to suggest that the same rate of dividend per share 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 would be regarded as wishing to benefit;
- The ‘non-waiving’ shareholder would pay less tax on the dividend than the ‘waiving’ shareholder.
HMRC specifically look for an element of ‘bounty’ in the ‘waiver’ such that it can be determined that the company would not have been able to make the payment out of the available distributable reserves if the waiver had not taken place. The extent of that ‘bounty’ is then assessable on the shareholder who has waived the payment.
Example 1: Husband and wife company - dividend waiver
Mr and Mrs H and are the only directors of ABC Ltd. Mr H owns 80 ordinary shares in the company and Mrs H owns 20 shares, with the same voting rights and entitlement to dividends.
They wish to distribute profits of £25,000 as a dividend. Mr H works under PAYE for another firm and as such is a higher rate taxpayer. He does not want the dividend to be taxed at higher rates and does not need the additional money to live on. In this situation, Mr H can waive his right to the dividend and if Mrs H only receives her share (£5,000) then there with be no element of ‘bounty’ so long as Mr H’s dividend remains within the company and is not distributed.
However, if the dividend is ‘waived’, but it is agreed that Mrs H receives an increased dividend of £1,000 per share (£20,000), then HMRC may challenge the waiver contending that Mr H has ‘settled’ his share on his wife. A dividend at this amount (i.e. £1,000 x 100 shares) could not have been paid from the company's profits on all the shares, so the waiver arrangement enhanced the dividend paid to Mrs H and as such was ‘bounteous’.
Further problems
Care is needed where, for example, one of the shareholders works full time for the company, whereas the other shareholders do not and those shareholders waive their entitlement in favour of the full time working director/shareholder. Again, this is common in husband and wife situations. The difficulty is that HMRC may look to tax the additional ‘dividend’ received as being increased salary in some cases.
Example 2: ‘Topping up’ income from the company
The number of issued shares in ABC Ltd is 100 ordinary shares, owned by three shareholders as follows:
A = 40 shares
B = 30 shares (full time employee)
C = 30 shares.
The company’s board wishes to have B’s efforts as full time employee rewarded, such as he can receive more money out of the company than the share split will allow. He does not wish this increased amount to be taken in the form of salary (not least for increased NIC reasons) and as such the board are looking into the possibility of dividend waivers. Unfortunately, whether by dividend waiver or the issue of a new class of share, HMRC might look at additional dividends in this scenario as possibly being disguised remuneration.
Practicalities
- It is important to follow the legal and practical requirements for a valid dividend waiver, such as the need to draw up a formal deed that is signed, dated, witnessed and lodged with the company.
- Interim dividends must be waived before payment. The waiver of a final dividend needs to take place before the shareholders’ approval.
- Preferably do not ‘waive’ every year. HMRC often look at the pattern of dividend waivers, especially those made on a regular basis, to determine whether there has been a diversion of income. They are looking to see whether there is a ‘set plan’ to be caught under the ‘settlements’ legislation, not least if the result is an overall reduction of income tax charged as a result of undertaking the waiver.
- If at all possible it should be shown that there is a commercial reason for the waiver and it is not just being undertaken for tax reasons (e.g. the waiver results in keeping the funds within the company for expansion reasons etc.).
- In order to make sure that the waiver is outside the scope of inheritance tax (particularly IHTA 1984, s 3 – transfer of value) the waiver deed should be executed within twelve months before any right to the dividend accrues (IHTA 1984, s 15).
Other options to waivers
Other methods of not claiming dividends include:
The shareholder who does not want the dividend transfers some or all of his shares to another shareholder(s) before the declaration of the dividend. This is likely to have other tax consequences (e.g. capital gains tax), which would need to be considered in advance. It would also be difficult for shares to be reissued to him at a later date, plus the whole procedure needs board approval; and
The shares could be re-categorised into A and B shares. It may then be possible to declare a dividend on one type of share only (e.g. the ‘B’ shares). However, care is needed (e.g. the dividend recipient should already be receiving commercial remuneration from the company), and the full tax (e.g. under the ‘employment related securities’ provisions) and non-tax (e.g. share valuation implications) will need to be considered. Expert professional advice may be necessary.
Practical Tip:
Dividend waivers can be an effective way of reducing the shareholders’ overall income tax bill, but it is important to ensure (among other things) that the dividend declared per share, multiplied by the number of shares in issue, does not exceed the amount of the company’s distributable reserves.
