Alphabet Shares
Alphabet shares allow a company to assign varying rights to its shareholders, i.e. some shareholders can have the right to get dividends but not to vote or appoint a director. Similarly, some alphabet shareholders might have limited voting rights with entitlement to a different rate of dividends. A company can issue alphabet shares if its existing shareholders approve of it, while the rights attached to these shares are defined in a companyโs articles of association. The alphabet shares are denoted by alphabets such as โAโ shares, โBโ shares etc., thus deriving their name.ย
Alphabet Shares come with their set of tax implications and liabilities. For instance, you have set up a new organisation in which you and your spouse intend to introduce alphabet shares. HMRC doesnโt approve of these shares, but is it now allowed to save tax through them?
Alphabet Shares Tax Planning
Dividends act as a tax-saving way to distribute a companyโs profits; the amount paid out as dividends can be different as per, letโs say, the seniority of the shareholders. Alphabet shares can be used in this regard, i.e. they have special rights associated with them, which can be used to dictate different rates of dividends to different shareholders. HMRC allows it if the only thing common between the shareholders is the company and they arenโt related in any other way. If shareholders are part of the same family, HMRC might reconsider the legitimacy of such an arrangement.
Video: How Helpful Can Alphabet Shares be?
The Settlement Legislation
According to HMRC legislation (ITTOIA 2005, Pt 5, Ch 5), a settlement is defined as: โ…any disposition, trust, covenant, agreement, arrangement or transfer of assets.โ The settlement legislation limits an individual to gain a tax advantage resulting from a transfer of income from one family member to anotherโwhich effectively is a settlement.ย In the case of spouses, the diverted income from one to the other toย reduce the tax charge still falls in the net of the settlement legislation and will be taxable for the spouse who earned it.
Point to be Noted
The scope of the settlement legislation is limited, and therefore, it is not applicable where the entire asset is transferred to a spouse and not just the income resulting from it. Company shares, though assets, when used with an intention to give out different rated dividends to spouses, does fall under the scope of the settlement legislation,ย a precedent is available in the House of Lords regarding the โArctic Systemsโ case in which a transfer of income and preference to dividends (no NIC obligation) instead of salary was deemed unallowable as an element of bounty was involved, thus, a settlement.ย
Limitations of Normal Shares
Letโs suppose Tom is the owner and director of a company, Aorg Ltd. Tom pays tax at a higher rate as compared to his wife, Sandra, who has a variable income depending on how well she does as a self-employed. Tom wants to give some of his dividends to Sandra to take advantage of her unused nil-rate and basic rate band. This can be achieved through a transfer of shares from Tom to Sandra, but as the shares are general, Sandraโs dividend rate will be identical to that of Tom. The problem with this arrangement is that if Sandra makes a high profit stemming from the variable nature of her income, it might push her overall income into higher tax rate bands, thus compromising the arrangementโs purpose.
Solution
The imperfect nature of the aforementioned arrangement can be perfected through issuing alphabet shares (letโs suppose โAโ ordinary shares), which might have the same rights as the ordinary shares of Tom, but the rate of dividend associated with them will differ. Aorg Ltd. can issue these shares to Sandra to pay her dividends at a different rate at different times.ย
Point to be Noted
The arrangement now, however, is intricate, but it might still attract HMRCโs attention and might be discarded as an unfair avoidance, i.e. if one class of shares is paid at a rate that would make it impossible for other classes to get paid at the same rate in comparison the profit available. Suppose a profit of ยฃ50,000 is to be split between Tom, who owns 80 ordinary shares in Aorg Ltd., and Sandra, who has 20 โAโ ordinary shares (Alphabet shares) and the dividend rate for the ordinary shares is ยฃ550/share. If the same rate is applied for both Tom and Sandra (alphabet shareholder), the expected outflow, i.e. 55,000, exceeds the profit.ย
Solutionย ย
Although alphabet shares can be used to divide dividends among spouses and for tax efficiency purposes to skip HMRCโs radar, the dividend rate should be such that, if applied uniformly across all classes of shares, it doesnโt exceed the profit available. Always speak to an expert accounting firm before proceeding with complicated restructuring.
