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Are C shares the answer?

Are C shares the answer?

Husband and wife own a company 55/45 in his favour. He is the fee earner but the wife does some admin. He's had enough dividends to use up his BR band this year. Wife has about £2k left but has also invested £5k in a SEIS. Hence, she needs some taxable income to utilise the 50% tax relief.

A dividend waiver would work as there are sufficient reserves to pay her the dividend she needs and leave funds equivalent to his waiver in the company. However, waivers are messy as you have to keep track of them and ensure the dividends he would have had are not inadvertently diverted to her in a future distribution. Not sure how long you have to do this for, but there must be a minimum period otherwise you could just get round it by declaring a second dividend straight afterwards.

My original idea was to allot her one B share for a special dividend, but although the share would have voting rights, it would only add 0.99% to her shareholding. I fear it might be vulnerable to a challenge as "substantially a right to income" as it wouldn't really confer much more in terms of ownership rights than she has now.

We could make it 10 shares, but that would give her control of the company which they don't want. Neither are they happy with a 50/50 or near 50/50 split, even though it would be an outright gift of ordinary shares.

I suggested B shares for him and C shares for her giving him control in line with his earning power whilst retaining the flexibility to vary the dividends. However, that means she'd have less voting power afterwards than she did before, which could be construed as the C shares being "wholly or substantially a right to income", thus negating the spouse gifts exemption.

Am I worrying about nothing here or could there be a problem? I always thought ordinary shares transferred between spouses without restrictions couldn't be caught by the settlements legislation, full stop, but when you look at the situation in the round, it doesn't seem so cut and dried.

Any insights?

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By cfield
29th Feb 2016 10:37

Possible solution

Just had a sudden thought. Maybe the solution is for the C shares to allow the right to receive a one-off dividend on 31 March each year if a) there are sufficient distributable reserves to do so, and b) the holder can obtain tax relief on the dividend and/or pay tax on it at the basic rate.

That would surely bestow the shares with sufficient rights of ownership to offset the loss of voting power inherent in the whole arrangement and avoid the C shares being "wholly or mainly a right to income".

The lack of feedback so far suggests to me that nobody really knows. Either that or they're not sure what I'm on about!

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29th Feb 2016 10:52

Seems a bit too obvious but why do the B shares need to have any voting rights?

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By cfield
29th Feb 2016 11:09

Voting rights

Practise_Accountant88 wrote:

Seems a bit too obvious but why do the B shares need to have any voting rights?

Because otherwise they would be "wholly or substantially a right to income" and hence not qualify for the spouse gifts exemption. Essentially they represent a dilution of the wife's voting power and could thus be treated as a settlement by her. Any dividends received by her husband on the B shares to use up his basic rate band (say if she had high profits from her own business) could potentially be taxed on her instead.

In general, if you're going to have alphabet shares, it is best of they all have the same rights of ownership, especially voting rights.

By the way, the wife originally paid for her 45 shares with the proceeds from her share of the partnership when the business was incorporated, so there was no settlement at that stage. Hence, we cannot treat it as a slight variation to the original arrangement.

 

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By Cleggy1
29th Feb 2016 11:02

42

The answer is 42

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By cfield
29th Feb 2016 11:12

Douglas Adams, you have a lot to answer for!

Cleggy1 wrote:

The answer is 42

Yes, I read Hitchhikers Guide to the Galaxy too. Only sensible answers please folks.

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29th Feb 2016 11:07

I always worry about alphabet shares, and the more of the alphabet that gets used, the more a target I see. I'm sure HMRC would too, and given the drive to maximise tax income, it wouldn't surprise me to see the settlements legislation used, however you interpret it.

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By cfield
29th Feb 2016 11:14

Alphabet share worries

SteLacca wrote:

I always worry about alphabet shares, and the more of the alphabet that gets used, the more a target I see. I'm sure HMRC would too, and given the drive to maximise tax income, it wouldn't surprise me to see the settlements legislation used, however you interpret it.

Alphabet shares can only be attacked if people start taking away voting rights, etc. They're a lot less messy than dividend waivers.

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29th Feb 2016 11:23

Agreed

cfield wrote:

SteLacca wrote:

I always worry about alphabet shares, and the more of the alphabet that gets used, the more a target I see. I'm sure HMRC would too, and given the drive to maximise tax income, it wouldn't surprise me to see the settlements legislation used, however you interpret it.

Alphabet shares can only be attacked if people start taking away voting rights, etc. They're a lot less messy than dividend waivers.

Oh, I don't disagree. I'm not a particular fan of dividend waivers (and especially not recurring but variable waivers). My point was more that just about any structure now comes with a risk.

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By Ruddles
29th Feb 2016 11:42

Wrong

cfield wrote:

Alphabet shares can only be attacked if people start taking away voting rights, etc. They're a lot less messy than dividend waivers.

Even with full voting rights etc, HMRC have indicated that they might challenge alphabet share dividends if their use amounts to nothing more than a waiver. How likely a challenge, and whether such a challenge would be successful, is another matter.

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By cfield
29th Feb 2016 11:54

Waivers

Ruddles wrote:

cfield wrote:

Alphabet shares can only be attacked if people start taking away voting rights, etc. They're a lot less messy than dividend waivers.

Even with full voting rights etc, HMRC have indicated that they might challenge alphabet share dividends if their use amounts to nothing more than a waiver. How likely a challenge, and whether such a challenge would be successful, is another matter.

Waivers are fine so long as the waived dividend remains in the company and is not distributed to other shareholders. The company must be able to afford the whole dividend if the waiver had not taken place, so if a dividend is declared that uses up all retained profits (or enough to leave insufficient reserves to cover the waived dividend), the waiver is a settlement in its own right, even if the shares themselves are covered by the gifts exemption.

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By Ruddles
29th Feb 2016 13:45

My (and Portia's) point exactly

cfield wrote:

Waivers are fine so long as the waived dividend remains in the company and is not distributed to other shareholders. The company must be able to afford the whole dividend if the waiver had not taken place, so if a dividend is declared that uses up all retained profits (or enough to leave insufficient reserves to cover the waived dividend), the waiver is a settlement in its own right, even if the shares themselves are covered by the gifts exemption.

If for example a dividend is declared on B shares that leaves insufficient reserves to cover the same rate of dividend on other share classes you've got a potential problem. Voting rights etc are irrelevant.

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By cfield
29th Feb 2016 14:48

Dividends paid on one class only

Ruddles wrote:

If for example a dividend is declared on B shares that leaves insufficient reserves to cover the same rate of dividend on other share classes you've got a potential problem. Voting rights etc are irrelevant.

Based on para 72 of the Patmore case alone, you are correct in coming to that conclusion. However, para 42 also states "the B shares had no special rights to dividends and it was accepted by both parties that they ranked equally with the A shares on dividend rights". I would assume reading this that the second part of that statement is consequential to the first.

That being the case, it seems a special dividend on B shares wouldn't be a settlement if the shares confer the right to receive that dividend. It would then be the B shares themselves that are the settlement, and if they satisfy the gifts exemption, the dividend cannot be assessed on the husband.

Having said that, can the right to receive a special dividend mean that the B shares are "wholly or substantially a right to income" for that reason alone, or might the existence of voting rights, etc, still win the day? In Arctic Systems, The House of Lords decided that voting rights (even if never exercised) were sufficient to negate the "right to income" exception. On that basis, surely it doesn't matter if the right to receive a dividend is for a special dividend relating to B shares only or for a dividend paid on all share classes.

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29th Feb 2016 11:15

The answer would have been to have subscribed for the SEIS shares in the husband's name and then transferred them to the wife.

http://www.bailii.org/uk/cases/UKFTT/TC/2010/TC00619.html

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By cfield
29th Feb 2016 11:22

SEIS

Portia Nina Levin wrote:

The answer would have been to have subscribed for the SEIS shares in the husband's name and then transferred them to the wife.

http://www.bailii.org/uk/cases/UKFTT/TC/2010/TC00619.html

Yes, but sadly she didn't.

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29th Feb 2016 11:51

Nobody noticed the link to Patmore then? Where a dividend paid on the B shares to the wife, was, in effect, treated as being a settlement.

The judge actually started off by saying that the settlements legislation did not apply, but then went on to say that a proportion of the dividends were received by the wife as the husband's constructive trustee (that would be a settlement then!) and so they were taxable on the husband as his income (just like what the settlement's legislation does!).

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By cfield
29th Feb 2016 14:20

Patmore

Portia Nina Levin wrote:

Nobody noticed the link to Patmore then? Where a dividend paid on the B shares to the wife, was, in effect, treated as being a settlement.

The judge actually started off by saying that the settlements legislation did not apply, but then went on to say that a proportion of the dividends were received by the wife as the husband's constructive trustee (that would be a settlement then!) and so they were taxable on the husband as his income (just like what the settlement's legislation does!).

Patmore is a totally different kettle of fish. The B shares in that case were non-voting so clearly fell foul of the "wholly and substantially income" exception. In any case, the wife's dividends were always intended to pay off the mortgage used to buy the business (which the husband was jointly liable for) so the B shares were never an outright gift anyway.

Having said that, the wife in my clients' case uses her dividends to pay for school fees, and if the contract with the school is in joint names, it seems they would be applicable for the benefit of the donor, and hence taxable on him, at least as far as the C shares are concerned.

In Patmore, the Judge concluded that the wife was entitled to 42.5% of the total dividends in line with her 50% interest in the 85 shares bought from the Hensons so the settlement was actually the other way, by the wife on her husband. This was reflected in the decision to reduce the assessments on the husband.

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29th Feb 2016 11:59

Oh dear.

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29th Feb 2016 12:12

The issue seems to be

That you want to set something up purely for the sake of giving the wife extra dividends without changing anything else about the company but want HMRC to be unable to challenge on the grounds that it is purely for the sake of giving the wife extra dividends without changing anything else about the company.

I think there's a problem inherent in this situation.

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29th Feb 2016 12:22

The answer is, and has always been, in ITA 2007, sections 257H and 257HE.

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By cfield
29th Feb 2016 13:40

ITA 2007

Portia Nina Levin wrote:
The answer is, and has always been, in ITA 2007, sections 257H and 257HE.

This is all to do with SEIS. I don't think they would want to transfer the SEIS shares into his name just for tax purposes. They're quite risk averse with tax planning in general actually. We'll probably end up going with a normal dividend based on existing shareholdings, which might not be a bad thing with the new dividend tax looming. Doesn't look like they can stay under the higher rate threshold any time soon (not with huge school fees to pay) and they don't want a company loan to tide themselves over either.

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29th Feb 2016 14:51

Your up against it then.

[

This is all to do with SEIS. I don't think they would want to transfer the SEIS shares into his name just for tax purposes. They're quite risk averse with tax planning in general actually. We'll probably end up going with a normal dividend based on existing shareholdings, which might not be a bad thing with the new dividend tax looming. Doesn't look like they can stay under the higher rate threshold any time soon (not with huge school fees to pay) and they don't want a company loan to tide themselves over either.

[/quote]

Sounds like your hands are tied. "They're quite risk averse with tax planning"... "don't want to take a company loan" You don't have much to work with by the look of it. Also you have asked for "any insights" but your counter arguments to the insights (problem & solutions) posed by others including the lovely lady seem very well versed.

It also seems like your looking for someone to endorse it when clearly there is some doubt in your own mind over it.

Interesting problem and im watching this thread keenly for my own future reference.

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By cfield
29th Feb 2016 15:05

Just what I was looking for actually

bumpdinkwhallop wrote:

Also you have asked for "any insights" but your counter arguments to the insights (problem & solutions) posed by others including the lovely lady seem very well versed.

It also seems like your looking for someone to endorse it when clearly there is some doubt in your own mind over it.

Interesting problem and im watching this thread keenly for my own future reference.

Yes, I was hoping for endorsement, but I was also looking for potential (or actual) snags and this is exactly the sort of devils advocate feedback I wanted before recommending a way forward. Patmore is highly relevant and needs to be taken on board. As I suspected, it is indeed not as cut and dried as I thought.

Not sure about the lovely bit though :-)

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29th Feb 2016 15:12

Everyone is lovely when winter finishes

It was a good post. Some very good comments all round.

What are you going to do......... C shares or stay safe?

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By cfield
29th Feb 2016 16:45

Clients' decision

bumpdinkwhallop wrote:

What are you going to do......... C shares or stay safe?

Not up to me. It will be the clients' decision. I will put forward both options with arguments for and against, and possible solutions, and then leave it up to them.

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By Ruddles
29th Feb 2016 15:51

I'm not interested in Patmore

I was responding only to the erroneous statement that alphabet shares will be attacked only if voting rights etc are removed. The point is that HMRC clearly state that they may look at alphabet dividends if there is any bounty involved, ie if they've been used as an alternative to waivers - the rights attaching to the shares are, in this context, quite irrelevant. Have a look at example 13 at TSEM4225.

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By cfield
29th Feb 2016 17:13

TSEM4225

Ruddles wrote:

Have a look at example 13 at TSEM4225.

Yes, I take your point. We should ensure there are sufficient reserves to pay the same dividend on all classes even if restricted to one class. However, if the shares on one class give a right to receive a certain dividend, it seems to me that they cannot be treated as failed waivers even if you couldn't pay that dividend on the other shares. And if they have voting rights, etc, they presumably cannot be challenged as wholly or mainly a right to income either, unless they can separate out the right to receive a certain dividend from all the other rights and treat that as the settlement on its own.

In practice, I think this will be well below the HMRC radar. So far they have only attacked arrangements outside the norm.

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By Cleggy1
29th Feb 2016 17:08

Reclassify H&W shares

Why not reclassify shares as A & B shares so H gets 55 A and W gets 45 B. Both A & B rank pari pasu except for dividends where by a different dividend can be paid to each class of shares.

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29th Feb 2016 17:41

WHAT IS THE PROBLEM WITH A WAIVER?

"A dividend waiver would work as there are sufficient reserves to pay her the dividend she needs and leave funds equivalent to his waiver in the company. However, waivers are messy as you have to keep track of them and ensure the dividends he would have had are not inadvertently diverted to her in a future distribution. Not sure how long you have to do this for, but there must be a minimum period otherwise you could just get round it by declaring a second dividend straight afterwards"

The professional fees for a waiver[ which can be expressed as applying only to dividends payable for a predetermined short period] are less than for creation of alphabet shares.

There is no problem with successive waivers , provided at each declaration there are sufficient funds and distributable profits to pay the dividend declared [as xp per share]  to all shareholders.

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