Dividend waivers or alphabet shares

Dividend waivers or alphabet shares

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I have a company with three shareholders. The father and son own 75% and the 25% shareholder/director is non family. At the moment his dividend is £10,000 per year and as the director doing all the work for the company is high salary takes him into the higher tax bracket. Would it be legal for the father and son shareholders to waive part or all their dividends and for the non family shareholder to reduce his salary to £10,000 per year and to take a net dividend of £27,000? The distributable profits are about £40,000 per year although there profits in reserve that have not been distributed.

If I cannot raise the dividend legally as above would the only way of getting the 25% shareholder a more tax efficient share of the profits be for the father and son to transfer some of their shares to the non family member? Obviously they would not want to lose control of the company.

Do I understand rightly?:-

1) The family directors keep their 75% shareholding and the non family still has his 25% shareholding of the now Ordinary A shares.

2) The non family member then receives non voting/ non share of value of company winding up value Ordinary B shares. He gets 75% of these shares. The family members take 25% Ordinary B shares.

When the results are known the shareholders vote no dividend to the Ordinary A shares and vote £36,000 to the Ordinary B shares. This then results in the non family shareholder, who is also a working director taking on at least 75% of the workload of all 3 director/ shareholders, receiving a dividend of £27,000 and the 2 family members then receive a dividend of £4,500 each. By doing this the company ends up with more taxable income and takes both of the 2 family shareholders out of the higher tax bracket. The 2 family directors are also director/shareholders of another limited company which is completely family controlled.

Replies (20)

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RLI
By lionofludesch
08th Jan 2014 12:53

Shaky Ground Here

For the dividend waiver to be effective, the company would need to be capable of paying out a dividend on all the shares.  So for £27000 to be paid to the 25% shareholder, you'd need £108,000.  Obviously, this year's distributable profits aren't enough but you say there are some left from previous years.

Alphabet shares ?  Not worth the trouble imho.  My experience is that the clients can never keep up with the formalities.  You may as well invite HMRC to pop round for an enquiry.

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By johngroganjga
08th Jan 2014 13:12

Not sure why alphabet shares are such trouble compared with dividend waivers.  You only have to re-organise the shares once but you have to deal with divided waivers continuously forever.  The formalities for clients to keep up with are also fewer if they can just pay dividends when they want without having to worry about executing waivers each time. .

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Euan's picture
By Euan MacLennan
08th Jan 2014 13:29

Alphabet shares

I agree with John.  Dividend waivers are a hassle every time you want to declare a dividend, but alphabet shares only have to be set up once.

Your arrangement seems rather complicated.  I would re-organise the company's existing shares into 75 A and 25 B ordinary shares for the family and non-family shareholders respectively, the shares to rank pari passu in all respects except the ability to declare different dividends on the A & B shares.

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Replying to lionofludesch:
By LittleWhiteBull
08th Jan 2014 13:50

Reply to Euan

Euan MacLennan wrote:

I agree with John.  Dividend waivers are a hassle every time you want to declare a dividend, but alphabet shares only have to be set up once.

Your arrangement seems rather complicated.  I would re-organise the company's existing shares into 75 A and 25 B ordinary shares for the family and non-family shareholders respectively, the shares to rank pari passu in all respects except the ability to declare different dividends on the A & B shares.

I take it then that company would vote a £9,000 dividend to the A shareholders and £27,000 dividend to the B shareholder without any problems coming to the company's door from the company's act or HMRC but at the same time making the B shares non voting or of no value on winding up or sale of the company or business.

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Replying to Red Leader:
Euan's picture
By Euan MacLennan
09th Jan 2014 12:12

Why non voting?

LittleWhiteBull wrote:

I take it then that company would vote a £9,000 dividend to the A shareholders and £27,000 dividend to the B shareholder without any problems coming to the company's door from the company's act or HMRC but at the same time making the B shares non voting or of no value on winding up or sale of the company or business.

I do not understand why you wish to deprive the non-family shareholder of his existing rights to a 25% vote (the family can outvote him, so his vote is hardly worth anything) and to a 25% distribution on the winding-up or sale of the company - after all, he is the one who is contributing 100% to the value of the company.

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Replying to Mrbailey:
By LittleWhiteBull
09th Jan 2014 19:21

Reply to Euan

Euan MacLennan wrote:

LittleWhiteBull wrote:

I take it then that company would vote a £9,000 dividend to the A shareholders and £27,000 dividend to the B shareholder without any problems coming to the company's door from the company's act or HMRC but at the same time making the B shares non voting or of no value on winding up or sale of the company or business.

I do not understand why you wish to deprive the non-family shareholder of his existing rights to a 25% vote (the family can outvote him, so his vote is hardly worth anything) and to a 25% distribution on the winding-up or sale of the company - after all, he is the one who is contributing 100% to the value of the company.

I lost the plot a bit. Originally I was going to leave him with his 25% voting A shares and give him 100% of the B shares. I have advised client to remove his A shares and issue 25% B shares.

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By User deleted
08th Jan 2014 15:13

Alphabet shares

Although easier to administer than constant waivers, HMRC's view (I'm not saying that I agree with it, but it could result in 'discussions' being had) is that alphabet shares are often little more than structured waivers.

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Replying to Justin Bryant:
Euan's picture
By Euan MacLennan
09th Jan 2014 12:08

What is your point?

BKD wrote:

Although easier to administer than constant waivers, HMRC's view (I'm not saying that I agree with it, but it could result in 'discussions' being had) is that alphabet shares are often little more than structured waivers.

I don't understand your point.  If HMRC accept dividend waivers, why would they object to alphabet shares on the grounds that they are structured waivers?

The problem with both methods is that HMRC may challenge them on the grounds that they are disguised remuneration - which of course they often are, not least in this case.

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By User deleted
09th Jan 2014 12:29

My point, Euan ...

was that where a waiver doesn't work because of an insufficiency of reserves, some think that the solution is to use alphabet shares. HMRC's view is that in such a case the use of alphabet shares can confer bounty just as a waiver can.

My post was in response to the preceding one, which assumed that alphabet shares can be used without fear of HMRC interest. The point being that such an assumption may be dangerous.

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Nichola Ross Martin
By Nichola Ross Martin
09th Jan 2014 13:09

Probably best to avoid the use of 'bounty'

as the settlement provisions don't seem to be the issue.

Whilst many private companies have different share classes I think that your main issue is Part 7 ITEPA 2003 - employment related securities. If you create a salary sacrifice and start converting salary into dividend income HMRC may well charge you NICs on the basis that it is still earnings. You also need to consider the impact of any changes to shares because you may well trigger an income tax charge to. Case law: there is lots on this but Grays Timber will tell you what happens when you start adding value to shares (as I think that you will if you start waiving or changing share classes) and PA Holdings is the classic with regard to NICs and dividends.

Virtual Tax Partner support for accountants and their clients

http://www.rossmartin.co.uk

 

Thanks (1)
By Steve Kesby
09th Jan 2014 15:41

HMRC have successfully argued...

... that dividends paid by an employer company are not remuneration of the shareholder employees, but an application of  the company's profits. See Eyre v Finnieston Engineering 7 TC 74 discussed in BIM37705.

PA Holdings used a scheme involving a second company whereby they got a deduction for the payment being made, whilst the intention was that the employees got a low tax charge and there would be no NIC on the dividends.

The true character point in PA Holdings simply matches the character of the amount received by the employee with the character of the amount that has left the employer.

In Eyre v Finnieston Engineering there's no disparity, so I'm personally not convinced that PA Holdings can be applied in preference to it. So there's then S. 716A of ITEPA 2003 to contend with, which ought also to pull any amount out of a charge to NIC.

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Nichola Ross Martin
By Nichola Ross Martin
09th Jan 2014 17:14

I'm not persuaded on that

The case was 1916 and we are considering 2003 legislation. In any case Finnieston was trying to claim tax relief on dividends, the query here is about trying to change employment income into dividends, not vice-versa. PA Holdings went to the Court of Appeal - I've no concern about dividends being taxed as dividends although I'd be careful about Part 7 following the Grays decision and NICs.

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Nichola Ross Martin
By Nichola Ross Martin
10th Jan 2014 17:28

Form 42

And what goes on Form 42?

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Nichola Ross Martin
By Nichola Ross Martin
10th Jan 2014 20:23

Removal and replacement of shares

Really I was just thinking out loud as to what one would put on Form 42. The company will need to report the events and value the shares - that is assuming that the employee does not mind having his voting shares taken off him and new high yield (very valuable?) shares gifted. As you are also varying his employment then he should be given legal advice otherwise there could be some expensive legal problems when or if he realises what is what. I'm sorry this is a can of worms, perhaps the advice here is to start with an employment lawyer but then review what you plan from a tax angle.

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Nichola Ross Martin
By Nichola Ross Martin
13th Jan 2014 11:01

Employee 'stakeholder' share scheme?

Perhaps this is a good time to think of the new employee shareholder share scheme? Basically you give shares in return for giving up employee rights, less chance of attack by HMRC on dividend policy as it is a government approved scheme. As you are going to have to contact an employment lawyer to make these changes and alter articles and shareholder agreements too you may as well go down an approved share scheme route.

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By Alvin1
27th Jan 2014 15:21

Blind faith


For the 25% director to give up his right to a high salary plus dividends, for a low salary plus a higher dividend at the whim of the family directors, shows a surprising amount of faith.  It could be construed as an effective way to get rid of him with out the inconvenience of redundancy payments.

I would have thought in these circumstances HMRC and trying to pay less tax are the least of his worries.

Discuss!

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RLI
By lionofludesch
15th Jan 2014 12:12

Eh dear.

"Would have".  It's "would have".

Thanks (3)
Replying to gerrysims:
Euan's picture
By Euan MacLennan
15th Jan 2014 12:18

Pedant

lionofludesch wrote:

"Would have".  It's "would have".

A pedant after my own heart!

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RLI
By lionofludesch
15th Jan 2014 18:31

Professionals

We're supposed to be professionals.

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By geoffwolf
27th Jan 2014 14:18

profit uncertainty

From the non family director's perspective he is giving up part salary for the potential uncertainty of profit available for dividend and also giving up potential pension contributions.

 

 

 

 

 

 

 

 

 

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