Alphabet Shares or Dividend Waivers

Alphabet Shares or Dividend Waivers

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Client wants a structure that rewards the three individuals, (who are each putting in significant sums), to reflect the level of time commitment they will each put in to running the business. Balance of profits above this level to be pro-rata to shareholdings.(They are planning to have a shareholder agreement).

To be able to extract these profits as dividends is this better done via different classes of shares with voting ordinaries to take the balance of profits, or by a single class of shares with dividend waivers?

Can the obligation to waive some dividends be put in place via the shareholder agreement?

How likely is a HMRC challenge to the "alphabet" share dividends as emoluments? Is the situation differentiated from a PAYE evasion scheme because the individuals will all be investing significant funds?
Malcolm Veall

Replies (15)

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By Malcolm Veall
12th Jun 2006 17:13

Fair Enough!
SOGG,

Many Thanks for your time & effort on this thread. I confess that some of my postings were in part in the hope that one or two of the 700 people who have read it might add something.

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By Malcolm Veall
12th Jun 2006 14:35

Are One Man Co.s Any different?
SOGG,

I hear what you are saying.

As you are so pessimistic; do you think that s431 & s447 would catch one man companies operating on £5k Rem + Divi.s?

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By User deleted
12th Jun 2006 14:53

I think this correspondnece should now close !!
In the case of 'one man' companies, there is typically only a single class of shares; IR35 is an issue , of course, in many cases.
I think this correspondence should now close !!

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By User deleted
12th Jun 2006 09:41

Martin- I wish I could be as confident as you are
Without commenting on 'Red Dawn', whose opinions on other matters is contentious to say the least, the Revenue are not going to be bound by some vague expression of intention if they see what in their view is a tax 'plan'- given that in their eyes planning, avoidance and evasion are three sides of one coin-geometry was never my strong point!!

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By Malcolm Veall
12th Jun 2006 07:07

Is there a difference between entrepeneurs & staff
SOGG,

ITEPA s431B & s447 taken at face value seem to apply to single trader businesses which are incorporated. The consensus, (including Dawn), seems to be that these situations are not meant to be attacked. The point I am trying to make is that I think the situation of 2-3 traders who are setting up a small business should logically be as outside the rules as a single trader venture. The bona fide sharing of profits is different to disguised employment income of employees who are not the entrepeneurs who set up the venture.

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By Malcolm Veall
09th Jun 2006 10:46

Is it really so clear-cut?
Dear SOGG, I am well known for being particularly dense, so please be patient with me!

1. ITEPA - The real core of my query is whether there is a distinction between schemes to disguise employment income of key/high earning employees by alphabet shares and genuine entrepeneurs/investors who just want to split the profit shares from their SME venture in different proportions on different tranches of profits.

HMRC would like to tax all amounts received via PAYE, but that is not what the law necessarily says. Not least at ITEPA s716A. Their example at page 45 of the current year Form 42 guidance is an extreme example of disguised employment income:
(http://www.hmrc.gov.uk/shareschemes/form42-guidance.pdf)

Their view does have well known detractors:
http://www.taxation.co.uk/articles/50836/1.htm

Dawn P said that the FA(No2) anitavoidance is not aimed at SME entrepeneurs:
‘The purpose test … has been carefully designed to target complex, contrived avoidance arrangements that are used mainly to disguise cash bonuses …, it will be absolutely clear from what I say about the purpose test that this measure will not affect the taxation of those small businesses that do not use contrived schemes to disguise remuneration to avoid tax and National Insurance’.

2. Your LLP/Company setup - I am clearly misunderstanding what you mean. If the traders have no control over the company that is to be a partner in the LLP why should that company buy out the traders' interests in the LLP when a disposal is being negotiated?

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By User deleted
09th Jun 2006 13:09

Malcolm- we don't agree on the ITEPA issue
becuse s 431B is not within any if the sections covered by s 716A.

You are very optimistic if you think you can rely on ministerial assurances as to the purpose or philosophy of legislation, Pepper v Hart notwithstanding.

The purchase of individual members' interests in the LLP is the equivalent of giving incentive shares to employees , but without any of the ITEPA problems.

The terms of the LLP can for example provide for the purchase in due course by the company , as a member, of other members' interests.

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By Malcolm Veall
08th Jun 2006 12:00

What about profits in the meantime?
I understand the joyful flexibility of an LLP in escaping the straight-jacket on cars, accom, etc

I can see that the scheme puts all the gain on a successful eventual disposal into personal BATR & escapes the "double-tax" should the gain be in the company. BUT If the trade is in the LLP does your model assume that the profit share will be mostly with the company? Otherwise the traders will be into 22% IT + 8% Class4 and then 41% on their profit shares?

If the traders are not employees or directors of the company then they must be shadow directors - presumably itepa does not catch shadow directors?

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By wdr
08th Jun 2006 13:04

Malcolm, ,Alphabet shares don't escape Sch e/NIC and why are me
The Board of the company are certainly not likely to be persons in accordance with whose instructions the directors are accustomed to act.


Since 2nd December 2004 the effect of ITEPA s431B will impose Sch E and NI on the arrangement, as will FA (no2) 2005, Sch 3 Part 4. , so the anticipated tax savings of an alphabet scheme are illusory .

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By Malcolm Veall
07th Jun 2006 16:56

Dawn Makes Me Nervous
I (think) I understand the principle that ITEPA s447 could catch alphabet shares but that Dawn P has said that the FA 2004 changes are only aimed at complex avoidance schemes rather than SME trading company shareholder/directors - BUT that places reliance on HMRC not trying enforcement on.

Jon,

You say that it is easy enough to get round the ITEPA anti-avoidance - how?

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By Malcolm Veall
07th Jun 2006 11:14

They wouldn't have it
I tried to make them consider an LLP structure, especially as they are taking on chargeable assets which would attract BATR, but they would not consider it. I think it is a case of LLP still being an unknown to most of the world at large. (Plus of course they came to me with possibly as much as a week to set everything up so our meeting was trying to cover a welter of issues).

When you say the NIC position is better presumably you are talking about class 4 vs Class 1 rather than considering benefits.

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By newmoon
07th Jun 2006 12:31

I was wondering why llps are better for NI than limited companie
This comment had me wondering also, as I had thought previously that NI for llps was the same as for non limited partners.
With limited companies I always use alphabet shares rather than waivers, as I seem to recall that waivers are supposed to be drawn up by a solicitor to be effective (I know this doesn't happen on lots of occasions), and are therefore more complicated to deal with.

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By MBK
07th Jun 2006 13:15

Dividend waivers are a nightmare........
and should be avoided wherever possible. In particular the Revenue take the view that, if the whole dividend ignoring any waivers could not have been paid out of the then available profits, the waiver is ineffective.

Alphabet shares still work fine - but you need to understand the "newish" ITEPA legislation and ensure you are able to get around it. Not actually very difficult.

I don't buy the LLP route - overall tax costs will be significantly greater that way up to £300k of profit. After that there's hardly anything in it.

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By User deleted
08th Jun 2006 09:39

LLP's and NI; ITEPA
The NI issue relates to all 'benefits'; the LLP addresses as well ITEPA issues for share incentives.

It can pay in terms of such items as car benefits, for example, but more importantly in terms of avoiding the Sch E rules for share incentives.

The typical model is a combination of a trading company and an LLP of which it is a member.

The traders[typically] enter ito an LLP arrangement with the trading company, but are neither employees nor directors of it.

The LLP conducts the trade.

They can also co-invest with the trading company in other ventures, as they are employees of none of the companies concerned, again ITEPA does not apply.


The interests in the LLP can then be bought out in due course by the trading company; the bought out members will suffer only 10% CGT after BATR, rather than Sch E and an NI liabilty for the company. The company will of course have to use tax paid money to fund the purchase, but for the traders this is a much better deal.

Cost comparison.

Company spends £100 to buy out shares in a conventional alphabet scheme, employees suffer IT at 40% . company pays 12.80% NIC.
Net cost to company is 70% of £[100 +12.80]=£78.96, shareholder banks £60.

LLP route.
Company spends £78.96, member pays 10% CGT, net to member £71.06, 18.4% more.

The downside is that the Revenue may close the 'loophole' if they perceive it to be egregious.

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By User deleted
06th Jun 2006 17:21

Why not use an LLP?
You can write the terms any way you want-there is no ITEPA issue, and the NIC and benefit costs for the time being are much more favourable than for a Ltd.Co.

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