Generally speaking, in most owner managed businesses, dividends are more tax efficient than salary as dividends do not attract employees or employers NI.
Dividends must be paid in proportion to the number of shares held. So if a dividend of £10 per share is declared then the holder of 10 shares receives £100, the holder of 20 shares receives £200 etc.
That might not always be the preferred outcome. For example, in a husband and wife company one spouse might be a higher rate taxpayer whilst the other is a basic rate taxpayer and they would prefer the dividends to go to the latter.
Alternatively the shareholders might feel that one particular shareholder deserves more income than another shareholder. This typically happens in a start up company situation, with a small number of shareholders where one is putting more effort in setting up the business, putting in longer hours etc.
Of course it is possible for shareholders to waive dividends but this can be time consuming and messy especially if waivers are required on a regular basis.
A popular way to overcome this problem is to issue different classes of shares, often know as Alphabet shares because they are issued as A shares, B shares, C shares etc.
These shares can have different voting and capital rights but often they have identical rights. The only difference is that dividends can be voted on each class of share without reference to the other classes of share.
This is a perfectly legitimate commercial and tax planning tool, but one way that HMRC could potentially challenge this approach is by applying the “Settlements legislation”. HMRC would need to demonstrate that there was an element of bounty given, because a dividend on a class of share could not have been paid unless the other shareholder(s) had given up their right to receive their dividend on their class. So it is always wise to check the level of distributable profits before declaring any dividends.
It has been suggested in the past that Alphabet shares can be issued to staff in order to pay dividends rather than salary but that is fraught with difficulty and we would suggest should not be undertaken without proper tax advice.
In summary, used correctly Alphabet shares can be a very useful way of adding flexibility to the way that dividends are paid from a company to its shareholders, but do be careful that sufficient distributable reserves are available to do so.
If you would like to learn whether Alphabet shares could be useful in your business please get in touch.