Alphabet Shares Tax Planning
Setting up Alphabet Shares for tax planning reasons can be a popular way for company Directors to have the ability to declare different dividend rates to various shareholders.
A company’s constitution is contained in its Memorandum and Articles of Association.
Unless the Articles state otherwise, all shares rank equally. If the Directors recommend a distribution of profits through a cash dividend, each shareholder is entitled to a pro-rata share of the total number of shares held.
For tax planning purposes, if company Directors can declare different dividend rates to various shareholders, Alphabet Shares can become a tax-efficient vehicle for the distribution of company profits.
If one of the shareholders was also a company employee and paid income tax on his salary, another shareholder might not work full-time.
In this way, differential dividends can be used to optimise personal tax allowances.
Therefore, many small companies will create different classes of shares and give them names such as A, B and C. Hence the term Alphabet Shares.
ABC Shares then allows company Directors to declare different dividends for each class of share.
The frequently asked questions about Alphabet Shares Tax Planning
As property accountants, we are regularly asked about Alphabet Shares Tax Planning. We will look to answer the below questions in this Article.
“Are you paying too much tax?”
“Why should I use Alphabet Shares for tax planning?”
“What are the basics of Alphabet Shares?”
“How do I set up Alphabet Shares?”
“When can I use Alphabet Shares?”
“Will HMRC tax my Alphabet Shares?”
“What is the Settlements legislation?”
“Are Alphabet Shares the best method of dividend distribution?”
“Are ABC Shares tax-efficient?”
Are you paying too much tax?
Our property tax specialists help over 1,000 monthly retained UK landlords and property investors to minimise tax whilst building their wealth.
There are many reasons why people pay far more tax than they need to.
This is because:
-They do not know what they do not know.
-They have not spoken to a tax specialist to go through their situation to see what tax reliefs are available to them.
Their accountants or solicitors are not aware of the many reliefs available to their clients and, therefore, are not taken advantage of.
-Tax legislation changes but either the person or their accountant/tax specialist have not been made aware.
Why should I use Alphabet Shares for tax planning?
Alphabet Shares are not just used for differing types of dividends.
They may also be used to give entitlement separate from rules of ordinary shares. Their primary use is to enable payment of a particular class of shares without paying the same dividend to each shareholder.
ABC Shares can benefit if one of the shareholders is a higher or additional rate taxpayer and the others are either basic rate taxpayers or do not pay tax.
The most tax-efficient method of taking profits from a company is dividends.
In any company, there can be reasons to pay some shareholders less than others, such as reflecting seniority levels.
It’s worth looking at what constitutes a private Limited Company before issuing any Alphabet Shares.
This can be achieved by issuing different types (or classes) of shares so that different dividend rates can be paid. These are called Alphabet Shares.
HMRC can often decide to take a closer look at a company where the shareholders involved are family.
If you’re a Director in a company and are unsure about your position regarding tax planning and Alphabet Shares or the distribution of dividends, speak to a tax expert today.
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What are the basics of Alphabet Shares?
As property accountants serving thousands of UK landlords that purchase buy to let properties, we know that growing their businesses in a tax-efficient way is one of the main priorities they face.
Alphabet Shares allow a company to assign various rights to its shareholders, so some can have the right to get dividends but not to vote or to appoint a Director.
Some Alphabet shareholders might have limited voting rights with entitlement to a different rate of dividends.
A company can issue Alphabet Shares if its current shareholders approve, as long as the shares are defined in a company’s Articles of Association.
Alphabet Shares are denoted by letters such as ‘A’ shares, ‘B’ shares, and ‘C’ shares – hence their name.
Alphabet Shares come with their own set of tax implications and liabilities.
Alphabet Shares are particularly tax-effective when setting up a new trading company, and they can usually be set up at the start with little complication.
If you’re unsure how to make the most of Alphabet Shares, contact one of our UK tax team today.
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How do I set up Alphabet Shares?
Alphabet Shares are created by amending a company’s Articles of Association. For further information on Considerations when starting a limited company
It is critical to record the shareholders’ agreement on how differential dividends are to be determined.
Companies should make details as straightforward as possible in the Articles of Association. A bare minimum is to have a formal agreement signed by all shareholders.
The usual process is to create a new class of shares by setting these out in the company’s Articles and then adopting them by a special resolution of the company.
Having created Alphabet Shares, either new shares of the classes concerned must be allotted, or existing shares must be converted to the new classes. Sometimes, both processes will happen.
Any proposed changes must be approved by the company Directors and then approved by the shareholders.
Shareholders resolutions can be passed as written resolutions under procedures in the Companies Act (2006).
Notices of the resolutions and any statutory forms must be sent to Companies House.
More information on Who are Companies House?
When can I use Alphabet Shares?
Alphabet Shares are used for various purposes, often to enable a company to pay dividends at different rates per share to individual shareholders.
They are also used in family companies and joint ventures where certain rights are given to specific shareholders. This can include when appointing a Director.
When changing the shares of an existing company, care must be taken to prevent HMRC from invoking the Settlement legislation.
If shares are issued to family members at less than their market value and, because of their employment, the transaction may need to be reported to HMRC on Form 42 with a resulting income tax charge.
To prevent any issues with the Settlement legislation, any shares that are issues or gifted to family members should have full voting rights and capital rights.
Shares that carry the right to a dividend (but no voting rights) represent a right to income.
The gift of a right to income to a spouse or dependent child falls within the Settlement legislation.
If existing shareholders want other family members to become shareholders, it is better to reclassify and gift some of the existing shares rather than issuing entirely new ones.
Will HMRC tax my Alphabet Shares?
Dividends are a return on capital invested.
HMRC can try to argue that rather than being a dividend, a payment to a shareholder is, in reality, a payment for salary rather than a return on capital.
An employment ‘reward’ should be taxed under PAYE as salary and subject to NIC rather than a ‘return on investment’ with a tax credit of 20% and no NIC being due.
Alphabet Shares allow flexibility in the payment of dividends, allowing for future changes in the dividend paid to each shareholder without altering the shareholding.
When a company is sold, a share of at least 5% is required to claim Business Asset Disposal Relief for Capital Gains Tax purposes.
To prevent being challenged by HMRC that any dividends could have been paid unless one class of share was not allocated any dividend, the company should have sufficient profits so that dividends can be paid on all classes of shares.
What is the Settlements legislation?
The Settlements legislation prevents a tax advantage resulting from one family member diverting their income to another.
Where this involves spouses or civil partners, diverted income caught under the Settlement rules remains taxable on the spouse who diverted it.
The relevant tax legislation covers income derived from any Settlement, including disposition, trust, covenant, agreement, arrangement or transfer of assets.
Within owner-managed companies, a Settlement situation may apply where an individual enters into an arrangement of diverting income from one to another, resulting in a tax advantage.
These anti-tax-avoidance provisions are designed to prevent a person from diverting their income.
HMRC may also seek to apply the Settlements legislation where the level of dividend paid on a particular class of shares could not have been paid without minimal or no dividends paid on the other classes of shares.
If the dividend can only be paid if one class of shares receives no dividend, this may fall within the Settlement rules and be challenged by HMRC.
The scope of the Settlements legislation is limited and is not applicable where the entire asset is transferred to a spouse and not just the income resulting from it.
When used to give out different rated dividends to spouses, company shares do fall under the scope of the Settlements legislation.
If you’d like to discuss how Alphabet Shares can be used to save tax, speak to one of our tax experts.
Are Alphabet Shares the best method of dividend distribution?
Alphabet Shares can be used to give company employees dividends as part of their remuneration package.
Structured with proper tax advice, such schemes can be an incentive for employees and be a tax-efficient means of payment.
The Alphabet Shares are usually non-voting and may be redeemable at par value, allowing them to be returned should the employee stop working for the company.
In the context of family-owned companies and when looking to reward non-minor children, Alphabet Shares and dividend waivers can be used effectively.
Bespoke and careful tax planning is vital.
Are ABC Shares tax-efficient?
Alphabet Shares enable a company to differentiate between payments, allowing a dividend payout to be made without every shareholder receiving the same sum.
This is beneficial if there are different tax obligations among the shareholders.
Some employees prefer to be given Alphabet Shares as part of their overall package, as it represents a tax-efficient form of payment.
Dividends act as a tax-saving way to distribute a company’s profits.
Alphabet Shares can be used in this way when they have special rights associated with them, which can dictate different rates of dividends to shareholders.
HMRC allows this if the only thing in common between the shareholders is the company they work for and are not related.
If shareholders are part of the same family, HMRC’s stance can be different, and they may challenge it.
Limited Company: You may be interested in our main Article on Limited companies and tax structures.
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