For shareholders in limited companies, annual dividend payments often form all or part of the means to extract after tax profits from the company.
For companies with a single class of shares, dividends are paid at the same rate for each category of share according to the number of shares held, provided that each class of share is entitled to a dividend. This inflexibility can create tax leakage or inefficiency where the dividend is not needed or wanted by a shareholder, who may wish for the money to remain in the business. Although a dividend waiver offers a solution, there are common pitfalls under anti-avoidance legislation that should be considered before making this decision.
Examples of tax inefficiency can arise where one of the shareholders is a higher rate taxpayer and the others are either basic rate taxpayers or non-taxpayers, or if by taking the dividend the shareholder is affected by the higher income charge on Child Benefit.
When agreeing to waive a dividend the shareholder voluntarily gives up their entitlement to their share of the dividend. The other shareholders still receive their proportion of distributable profits in the proportion of each of their respective holdings but the shareholder who has waived his/her dividend receives nothing – his or her share of the profit remains in the company’s bank account.
The waiver can refer to a single dividend or a series of dividends declared during a specified period of time. An interim dividend must be waived before being paid, and a final dividend waived before being approved as a waiver afterwards could be construed as being a ‘settlement’. The settlements rules are anti-avoidance provisions and apply where the settlor (i.e. the person gifting an asset) retains an interest in the asset given away and the settlor or the settlor’s spouse benefits from the gifted asset. The transfer could also be deemed to be a transfer of value for inheritance tax purposes and even ‘value-shifting’ for capital gains tax purposes.
Dividend waivers that have been challenged by HMRC in the past have invariably been as the result of payments made in situations where the waivers have meant an increase in dividends for a company owner’s spouse (or children or the trustees of a children’s settlement). In practice, however, HMRC are only likely to make the ‘settlement’ point where the waiver is considered to create a tax advantage. As a consequence, it is generally not recommended that waivers should last for more than twelve months, as this may reduce the value of the shareholding, and potentially increase the value of those shareholdings that are able to enjoy higher dividends as a result, resulting in potential further tax implications.
HMRC’s interest is more likely to be aroused if the level of retained profits in the company is insufficient to allow the same rate of dividend to be paid on all issued share capital or where there is evidence which suggests that the same rate could not have been paid on all the issued shares in the absence of the waiver. To alleviate the possibility of HMRC interest it has been suggested that the deed used to effect the waiver should also state that the waiver has been made to allow the company to retain funds for a specific purpose, thus emphasising that there is some commercial reason for the waiver.
- The waiver is a formal deed that needs to be signed and witnessed;
- This must be executed before the entitlement to the unwanted dividend.
- It should be filed with the company’s statutory records in case of any challenge by HMRC.
Use them sparingly
Dividend waivers should be used sparingly, and dividends should not be waived every year, or too many times in one year. HMRC will look more closely at arrangements which are repeated and the practical effect of which reduces the overall tax payable. In addition, waivers should not last for more than twelve months as use of a long-term waiver could reduce the value of that shareholding, and potentially increase the value of those shareholdings that are able to enjoy higher dividends as a result.
If it is envisaged that waivers will be required on a more regular basis then consideration should be made to reorganising the share capital and creating different share classes to enable the dividend payments to be varied between different shareholders. A waiver must be a formal deed and must be signed, dated, witnessed and sent to the company. The drafting of a deed is a reserved activity, which only a member of The Law Society or the Bar can carry out.
Before deciding to waive rights to dividends, seek advice from relevant professionals to ensure that the waiver is used correctly and in line with HMRC guidelines. If you would like any help with this, then please contact one of our Business Tax team and we will be delighted to help.