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Save tax using the dividend allowance

29th Jul 2016
Tax Writer Taxwriter Ltd
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istock_Bart Sadowski

Paying dividends to family members can save tax, but only if the shares are acquired without triggering a tax penalty.

The dividend allowance allows every individual to receive up to £5,000 of dividend income per year, taxed at 0%. It doesn’t matter what rate of tax the individual pays on their other income, the first £5,000 of dividend income will be taxed at 0%. Estates of deceased persons are not entitled to the dividend allowance which may create problems for executors in the future.   

This tax-free slice of income can be exploited within family companies by paying small dividends to the spouse, adult offspring, or other relative of the company owner. However, those individuals can only receive a dividend from the company if they hold a share which entitles them to receive the dividend.

My earlier article, Giant mistake leaves taxpayer with huge bill, demonstrates what can go wrong if dividends are paid to someone who is not a shareholder. It is thus essential to follow the correct company secretarial procedures when issuing shares and paying dividends.

Shares in issue

Your first step should be to examine the amount of authorised and issued share capital for the company. Many micro-companies operate for years with only one share in issue. If the company owner wants to spread their shareholding among members of their family, the owner needs to hold sufficient shares in order to pass some of his or her shares on.

Where only a few of the authorised share capital have been issued, more shares may need to be issued. Different classes of shares (eg A-shares, B-shares) will permit dividends to be paid at different rates and at varying times to the holders of each class. This will allow a good deal of flexibility in the payment of dividends, but beware of the settlements legislation (see below).

The different classes of shares can carry different rights to the assets on a winding-up or votes, but if the long term intention is to allow all shareholders to take advantage of entrepreneurs’ relief, the shares should carry also carry voting rights. To qualify for entrepreneurs’ relief 10% rate of CGT, the shareholder must hold at least 5% of the ordinary share capital, and 5% of the voting rights of the company. Preference Shares which have only an entitlement to a fixed dividend are not part of the ordinary share capital (ITA 2007, s 989). 

Gift of shares

A gift of shares between spouses or civil partners will be treated as a no gain, no loss transfer for CGT, so no taxable gain arises. Gifts of shares to other individuals can give rise to taxable gains. However, such gains could be held-over under TCGA 1992, s 165, assuming the company is trading and doesn’t hold significant amounts of non-business assets. Small gains may be covered by the donor’s annual exemption (£11,100).  

Settlement

If the gift of shares is regarded as a settlement rather than an outright gift, the dividends arising from those shares are treated as the income of the donor not of the recipient of the shares (ITTOIA 2005, ss 619-648). This issue was explored in depth in the case: Jones v Garnett [2007] UKHL 35, which was eventually won by the taxpayer. 

To avoid the settlements legislation applying, any shares issued to or given to family members should be ordinary shares with full voting rights and rights to capital on a winding-up. Shares should not be given to children aged under 18, as such a gift is likely to be treated as a settlement.

Income tax

Shares given to employees of the company can be subject to income tax as employment-related securities (ITEPA 2003, s 421B), but there is a general exemption from that legislation for gifts made as part of a family relationship.

Subscribing for shares

As an alternative to gifting shares, family members could subscribe directly for their shares. They should pay for those shares using funds they have earned or received from other sources, not out of from funds gifted by the company owner.

Knock-on effects

Although the dividend allowance taxes up to £5,000 of dividend income at 0%, that income uses up part of the tax band it falls into. It is also included in the calculation of the high income child benefit charge, and for £100,000 threshold that withdraws personal allowances.

The tax effect on the recipient of the dividend should be calculated before any dividend is declared or paid. Dividends must not be paid unless there are sufficiently distributable reserves held within the company.   

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Replies (17)

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By chewmac
29th Jul 2016 12:09

What an excellent succinct article. Will keep as useful reference point on the subject.

Thanks (3)
bike
By FirstTab
29th Jul 2016 13:12

Thank you Rebecca. Great article as chewmac says.

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By Matrix
29th Jul 2016 13:55

Thanks this is helpful and I agree that it is necessary to watch out for the dividend allowance using up the band it falls into. It may not be beneficial to transfer shares when the spouse's income is around £43k or £100k.

Unless the shares are new shares issued after 17 March and held for 3 years wouldn't the new shareholder also have to be an employee to qualify for entrepreneur's relief?

Thanks (1)
Replying to Matrix:
By Rebecca Cave
29th Jul 2016 14:15

The shares issued after 17 March 2016 may qualify for investors' relief which is completely separate and different relief to entrepreneurs' relief. Family mmebers of a company owner will not be able to use investors's relief.

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By Matrix
29th Jul 2016 14:26

OK got it. So any transferee would have to be made a Director or put on the payroll to qualify for entrepreneur's relief on any future sale (assuming >5% held for >12 months).

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Replying to Matrix:
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By BigBri
30th Jul 2016 15:37

So, enter auto enrolment for the one man bands!

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Jennifer Adams
By Jennifer Adams
29th Jul 2016 18:09

Thanks v much for this article Rebecca -an article that is not long such that it can be printed out and given to clients. If anyone wants to know the practicalities of creating Alphabet shares here is an article written in checklist format: 'Alphabet Shares: Get the Details Right'
https://www.accountingweb.co.uk/business/finance-strategy/alphabet-share......
the article also details the Settlement rules.

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Jennifer Adams
By Jennifer Adams
29th Jul 2016 18:17

...

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Jennifer Adams
By Jennifer Adams
29th Jul 2016 18:20

Sorry... two comments from me - I'm still not used to the new loading - now I've got to see how to delete one post...

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By Adaman
29th Jul 2016 22:29

Of course it is not a tax deductible expense in regards to corporation tax thinking from a micro business point of view.

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By kiwilondon99
01st Aug 2016 11:31

what is the posiiton where Overseas dividends are received- with say a wihtholding tax deducted @ source, with net received [ ie USA under a w8BEN ]

So, is this Tax allowable against TAX bill with the shares net div used as part of the allowance, - or do the tax and dividends get otherwise treated in a return

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By douglasganderson
01st Aug 2016 12:11

Would the £5,000 dividend allowance be available to a non uk resident. Person is out of UK but would be classed as temporary non resident at present as only out of country for 2 years.

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By sugar
01st Aug 2016 12:56

good to know - one Q - can a minor holding shares receive dividend from a ltd co and will div belong to minor or parents - when parents are also shareholders/directors in same ltd co ?

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By newmoon
02nd Aug 2016 13:19

Useful article, thank you.
Companies formed after 01.10.2009 don't have to worry about the Authorised Share Capital part, do they?

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By cfield
02nd Aug 2016 19:53

It's also worth noting that new shares can only be issued in accordance with the Articles or the Companies Act. Where there are already 2 shareh0lders (e.g. husband and wife) and they wish to vary their shareholdings or split them between different classes, it is most important that they follow the correct procedures to the letter for the new shares to be valid. In some cases, this may mean the shareholders giving formal authority for new shares to be issued in a written resolution, subscribing for them in proportion to their existing rights, and then transferring a given number in order to achieve the desired ownership.

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By cfield
02nd Aug 2016 20:01

As an alternative, they could always sub-divide the existing shares into smaller units (say 1 x £1 into 100 x 1p) using Form SH02 and then transfer the desired number to their spouse. This has the advantage of not requiring new shares to be issued, although you still have to watch the settlements legislation. In particular, it should be an outright gift with no strings attached.

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By Gone Sailing
22nd Dec 2016 18:47

Shares to spouse, and use of the £5,000 band, must be exercising many of us, but I am unclear on several detailed aspects, having read:
https://www.accountingweb.co.uk/any-answers/issuing-new-shares

So, newco (ish), 2 years old, one spouse has the only one share.

For shareless spouse to get shares:
Is there any distinction for tax and forms to complete between transfer and new issue?
What if the shareless spouse is employed as a bookkeeper / administrator?

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