Dividing company profits with family shareholders – will HMRC challenge this?

If you want to share your company’s profits with your spouse or family members and are thinking of issuing them with a different class of shares and paying them dividends at different rates and times, will you be challenged by HMRC?

Dividends

The most tax-efficient way of taking profits out of a business is generally to pay dividends to shareholders. As in most businesses, you may decide to pay some shareholders more than others, maybe because some are more senior, for example. You can achieve this by issuing different types of shares, in order for different dividend rates to be paid.

HMRC won’t object to this provided the shareholders are not connected, except through the business. Where HMRC will have more of problem is when the relevant shareholders are family members.

‘Settlements Legislation’

This legislation stops any tax advantages that family members can enjoy when income is diverted from one member to another. Under this rule, if the income is diverted to a spouse or civil partner it remains taxable on the spouse who was responsible for diverting it.

It must be noted that the above rules are not relevant if the asset (and not only the income it produces) is transferred from one spouse to another.

In the case of company shares, the House of Lords irrefutably decided in the Arctic Systems case, that where there is an intention to pay different dividend rates to each spouse, possibly at different times, you can’t completely escape this legislation.

Let’s look at the following example:

Bill is the sole director and shareholder of his company Acom Ltd., and is a higher rate taxpayer. His wife, Jean, receives variable profits of between £10,000 and £30,000 from self-employment. Bill would like to divert some of his dividend income to his wife in order to use her basic rate band and nil rate. He could achieve this by giving her some of his shares in the company. However, if he did that she would be entitled to the same dividend rate as him every time a dividend was declared. As a consequence, when Jean makes a good profit from self-employment, the added dividends might push her into the higher tax bracket, which rather defeats the object.

‘Ordinary A shares’

One answer to the above tax problem would be for Bill’s company to give a new class of shares to Jean. These shares would have identical rights to Bill’s, but would be called something different to his ordinary shares, such as ‘Ordinary A shares’. The company would then be able to pay different dividend rates for each different class of share and at different times.

It must be noted that HMRC may still question this arrangement and label it as unfair tax avoidance if the dividend rate paid on one class of share prevents an equal dividend rate on the other.

Let’s look at the above example again. Let’s assume Bill owned 100 ordinary shares in the company, and Jean owned 50 A shares, and there was enough profit in the company to pay £100,000 in total dividends. If Bill were to take a dividend of £750 per share, it would not be possible for Jean to be paid the same dividend rate, because it would equate to a total of £112,500, which is more than the total profit.

It is fine to use these types of shares to separate dividends between spouses as a way of saving tax, but it is important to pay them at a rate, which if applied to all of the different classes, would not be higher than the available profit.

To conclude…

HMRC may decide to challenge dividends paid at different rates where each spouse owns different share classes and the dividend rate paid to one spouse could not also be paid to the other without going beyond the available profits. You should be aware of this every time a dividend is paid.

For more information, visit http://tipsandadvice-tax.co.uk/download (TX D 18.22.05).

For advice or support regarding your business tax, contact ADM on 01242 679767 or email andrew@admaccountancy.co.uk

 

Photo by Thomas Drouault on Unsplash

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