Writing for UK200Group Tax Talk, BKL tax partner Anthony Newgrosh offers a reminder of the risks associated with alphabet shares and dividend waivers.
Alphabet shares and dividend waivers have been a much used and abused tool of the tax practitioner for many years as they have allowed companies to either disproportionately reward family shareholders or employees. However, in light of increased HMRC scrutiny, it is worth reminding ourselves of the various risks associated with such planning.
These may be summarised as follows:
The above provisions can be used to attack arrangements whereby income is diverted to a spouse, civil partner or minor child. This applies in the case of alphabet shares where dividends are effectively diverted from one shareholder to another but the use of dividend waivers are similarly potentially within the ambit of the settlements provisions. This was illustrated in the case of Buck v Buck whereby Mr Buck waived his dividends so to allow his wife to take a large dividend on her single share in the family company.
But the settlements legislation has its limits. In particular, TSEM4225 sets out that HMRC will normally only try to invoke its provisions where for example the dividends could not legally have been paid across all classes of shares in the absence of the waiver, or similarly the creation of separate share classes and an element of bounty was expected to be bestowed under the arrangements.
Employment related securities provisions
Alphabet shares have also been used to pay targeted dividends to employees so as to reduce income tax and more specifically NIC costs. Typically this has involved creating a separate class of shares for each employee which only have rights to dividends.
HMRC’s view as set out at ERSM60030 is that the increase in the value of such shares on the declaration of a dividend is subject to a Chapter 3B income tax charge (Securities with Artificially Increased Value). This doesn’t set aside the normal tax charge on dividend income and so can give rise to a triple whammy given also the potential exposure to NIC liabilities thereon.
Again though, such counter-action can only be taken in limited circumstances. Firstly, the shares must be employment related so equity acquired from family may be protected by virtue of the exemption in section 421B(3) of ITEPA. In addition, if the shares have full voting and capital rights, it is far harder for HMRC to impute an artificial increase in value each time a dividend is declared.
General Principles and Case Law
In the recent PA Holdings case, the Court of Appeal upheld that dividends could be subject to PAYE and NIC. However, the arrangements in that case were highly contrived and it was not clear how far HMRC would use it as a battering ram against the use of alphabet shares and dividends waivers in general.
We have now seen examples of HMRC arguing that dividends paid on a special class of shares, notwithstanding that they had full capital and voting rights, are remuneration and subject to both PAYE and NIC. We assume, although the Inspector does not seem to trouble herself with technical arguments, that it is their view that the payment represents a reward for services as an employee and is therefore within the ambit of section 62 ITEPA. (Indeed, the payment of targeted dividends to non-employee or directors has not been challenged.) Do also bear in mind that the required completion of Form 42 may now also give HMRC additional opportunity to link the issue of shares to employees.
In this case, the payment of dividends has been coupled with a salary sacrifice by the relevant individual. Such arrangements which show a smoking gun between reward for services as an employee and the payment of targeted dividends are undoubtedly at risk of challenge, although the argument remains as to whether the dividends have effectively been received in capacity as a shareholder or an employee.
When Can Dividend Waivers or Alphabet Shares be Used?
As it can be seen above, there is an increasing number of technical challenges to the use of such arrangements and in light of the current climate concerning tax-avoidance, practitioners are advised to use such techniques with caution. Certainly the creation of shares with highly restricted rights and/or in conjunction with salary sacrifices is not recommended.
However, in the context of family companies, and in particular, when looking to reward non-minor children, alphabet shares and dividend waivers can still be used effectively. There remains no one-size-fits-all solution though – bespoke, careful tax planning remains (as always) the key.
This article is also available via the UK200Group website.