27 Feb Using Alphabet Shares in a SME Business
Alphabet shares refer to shares issued by a limited company that have different rights attached to them as set out in the company’s articles of terms of issue. The shares are listed by a letter (‘A’, ‘B’ etc) and hence called alphabet shares. Businesses issue this type of share for various reasons.
Typically, a limited company starts up with a set number of ordinary shares – quite often 100. As the company grows, in order to distribute profits in different quantities to different people, alphabet shares are a good option to consider.
Creating a new type of share will have to be agreed by the directors and existing shareholders. There are a number of legal requirements to consider.
When might you use alphabet shares?
Used as a tax efficient way to pay dividends to employees as part of their annual pay to help to motivate them to be invested in increasing profit for the company. Under these schemes, often non-voting, redeemable shares are distributed so they can be returned to the business if the employee leaves the company.
To enable directors’ spouses or other family members to share in the financial profits of the business, alphabet shares can be a good option as you can attribute different levels of dividend to each person. However, you do have to be careful in terms of attracting attention from HMRC under Settlement Legislation (see below).
Proportion of control and profits can be distributed in a joint set-up between two or more independent companies or two or more families using alphabet shares. Each interested party will be assigned rights in terms of voting and distributing shares themselves.
If you only occasionally intend on distributing dividends disproportionately among ordinary shareholders, dividend waivers might be a better option than setting up alphabet shares.
For a shareholder to receive a different rate to another one, there needs to be a dividend waiver, which has to be agreed by all shareholders at each dividend period.
These are likely to be scrutinised by HMRC, in particular to ensure it is not being used to avoid paying tax.
Don’t get caught out by Settlement Legislation
When considering alphabet shares (and equally dividend waivers), you need to make sure that the arrangement is not against settlement rules.
One section in particular to note is Chapter 5 of Part 5 of ITTOIA 2005; s620 which explains a settlement as including “any disposition, trust, covenant, agreement, arrangement or transfer of assets”.
In order to avoid falling foul of these rules, they will need to be carefully structured.
- Not attributing any voting rights or issuing redeemable shares for example, will mean that the shares are “wholly or mainly a right to income” which will fall under the legislation. Employee schemes set up in this way need to be carefully managed.
- When gifting shares to family members it is recommended that they are given an active interest in the business, such as company secretary or director.
- Dividends should also be paid into a bank account where the recipient is named (this could be a joint account). In owner-managed businesses, the legislation may apply if it is considered that one director is diverting part of their income to someone else to avoiding paying tax.
- Other things to consider are that a dividend should be paid to each category of shareholder (A, B etc) to reduce the risk of HMRC suggesting that a dividend should not have been paid and it is being used to create a tax advantage.
- It is also important to remember that if you are looking to claim Entrepreneur’s Relief when you sell the company, a 5% share is required.
Efficient tax planning can be a bit of a minefield and it is important to speak to a professional for advice on how to manage this within the HMRC tax rules.
AJN helps businesses structure their shares in the best way and we can help you explore options that you might not have considered. Speak to us today for help with managing your tax planning.