Alphabet shares and family companies

We've previously discussed how you can issue further  ordinary shares of the same class in your company. In this article we're now going to discuss the circumstances when issuing Alphabet shares may be appropriate. 

Alphabet shares

What are Alphabet shares?

Put very simply Alphabet shares are shares that have been set up as different classes. You could issue A ordinary shares, B ordinary shares and so on.

When your company has different share classes it can potentially attach different rights for each type of share. For example, it may make restrict their voting rights in some way, or provide preferential treatment.  It also possible to pay different rates of dividends to different share classes (though see below). If you're a director and shareholder of the business you can also vote to change share classes.

Alphabet shares and family companies

Private companies are usually formed with just one class of ordinary share for the sake of expediency and simplicity. It's possible for new shares to be issued after incorporation though where new shares of a different class are issued to family members a number of complicated tax issues may arise in the following situations:

  • Spouses are given non-voting or shares with limited rights, or a disproportionate amount of dividends compared to other working shareholder
  • Shareholders waive dividends in favour of their spouse or minor children 
  • Minor children receive shares in their parents companies

These points are discussed in more detail below.

Family companies - income splitting

Income splitting is the term used to describe the practice of dividing your income with your spouse or civil partner in order to utilise any unused personal allowances or tax bands.

  • Because of the changes to dividend taxation, you might consider dividing your income to take advantage of your respective tax-free allowances and different tax bands. This may be particularly relevant where you are looking at tax efficient profit extraction from your company.
  • Issuing different classes of share might allow you or your spouse to receive the optimum level of dividends to use up your available allowances.
  • The risk of income splitting is that you might be caught by HM Revenue's Settlement Provisions - see below

HM Revenue's settlements legislation is an anti-avoidance measure that prevents income producing assets like company shares being divided between you and your spouse in order to maximise tax allowances. These rules also apply where assets and income are split with a minor child.  They do not apply to unmarried couples or to transactions between parents and adult children. 

When the rules apply, any dividend income is taxed as if the underlying share ownership has never changed. The income will remain the taxable income of the parent or spouse who gifted the shares.

Measures to avoid the settlements legislation

These provisions will not apply to shares in the following circumstances:

Where shares are an outright gift and some or all of the following apply:

  • When a gift of shares is executed by a deed of gift
  • The sale proceeds in the event of any disposal are paid into the recipient spouse's bank account
  • All dividends paid from the shares are paid out into the recipient spouse’s personal bank account rather than a joint account. 
  • Any shares gifted are ordinary shares with voting rights

Where the gift of shares is not wholly a right to income

If your company’s profits are wholly distributed to one shareholder under an alphabet share arrangement, HM Revenue may suspect that one spouse has given up their right to income in order to allow proportionally higher dividends to be paid to the other

Transferring the right to income is typically achieved by using a dividend waiver. This has no capital value (like a gift) though provides the other shareholder(s) with an enhanced right to income for the waiver period

The same effect is achieved where your company has Alphabet shares and the dividend voted to one spouse uses all of your company's available profits for distribution.   

A different class of company share may also have restricted rights (e.g. to assets on winding up) or be non-voting shares.

Any one of the above scenarios are likely to trigger HM Revenue's settlements legislation

It's therefore advisable to ensure that any new class of shares issued are voting and don't purely have the right to receive dividends. You should also diverting all of the distributable profits to one spouse.

Minor children and the Settlement Provisions

Where a minor unmarried child is gifted income-producing assets by their parents (for example company shares),any  income in excess of £100 p.a. arising from that asset (dividends on shares) will be taxable as their parents' income under the settlement provisions.

There's no doubt if set up correctly, Alphabet Shares can prove to be a flexible way of extracting profits from your family company, provided you avoid the pitfalls detailed above. 

For more useful information, check out our Ebooks here.

And if you'd like to know how we can help you with all of this, or with anything else, feel free to give us a call on 01202 048696 or email us at richard@tfaaccountants.co.uk.

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