Tax Efficient Dividend Payments - Using Alphabet Shares

Despite dividend tax rates being charged at 33.75% (higher rate taxpayers) or 39.35% (additional rate taxpayers), generally dividends remain the most tax-efficient method of taking profits from a company. 

On incorporation it is usual for all shares issued to be designated ordinary shares. However, where a company only has one class of share, the right to receive a dividend, to vote and to any proceeds of sale should the company be sold are usually pro-rata which might not be tax efficient overall.

'Alphabet shares' enable flexibility, being different classes of shares denominated by a letter (e.g., ‘A’ ordinary, ’B’ ordinary, ‘C’ ordinary shares, etc.). Under such an arrangement, each shareholder could still hold ordinary shares and even the same number of shares but of a different class, enabling the company to authorise dividend payments at different rates to each class of shareholder. Such arrangements are of particular use should one or more of the shareholders be taxed at 'higher rates' and the other shareholders are either 'basic rate' taxpayers or do not pay tax. 

When amending the share set-up of an existing company, care must be taken to prevent HMRC querying the scheme's validity and invoking the settlements rules, especially if the share mix is changed post-incorporation. The settlements legislation is intended to prevent an individual from gaining a tax advantage by making arrangements which divert their income to another person who is liable at a lower tax rate or is not liable to income tax.  However, the courts have established that for a settlement to exist there must be an element of ‘bounty', i.e., the provision of some value, without expecting something equivalent in return.

Therefore, the shares must be gifted outright, having capital rights and it would be preferable for there to be sufficient profits available such that any dividends could be paid on all share classes. A gift of shares to family members does not need to be reported to HMRC unless issued at less than market value or 'by reason of employment'. 

The likelihood of a challenge from HMRC is reduced where there is a commercial reason for having more than one class of share, where the shares have equal rights and where there is no link between the dividends received and salary foregone.