Are you part of a limited company distributing dividends to shareholders? If so, there may come a time when one or more shareholders choose to wave their rights to their share. Although this is perfectly acceptable, there are steps to follow so that HMRC does not view the waiver as tax avoidance.
How does a dividend waiver work?
Dividends must always be distributed evenly among shareholders. The amount will be split proportionally by the number of shares owned. Here is an example:
Distributable profits of £10,000, paid out at £100 per share
Shareholder 1 (owns 45%) = £4500
Shareholder 2 (owns 25%) = £2500
Shareholder 3 (owns 30%) = £3000
If shareholder 1 decided to waive their dividend payment, then shareholders 2 & 3 will still receive £2500 & £3000 respectively, and the £4500 will stay in the company.
On the other hand, the remaining £4500 could be split between the shareholders 2 & 3.
If shareholder 2 is the spouse or relative of shareholder 1, this dividend waiver could be viewed as tax avoidance.
Shareholder 2 may be paying a lower rate of tax for the current fiscal year, and shareholder 1 on a higher rate. Shareholder 1 could have ‘settled’ their dividend amount on shareholder 2 to avoid being taxed. If the HMRC can prove this is the case then shareholder 1 will be taxed at the higher rate, as if they have received the full dividend amount.
Keep in mind
- It is important that dividend waivers are only made for commercial purposes.
- They should not be regularly used.
- The dividend waiver itself must be formally executed and signed by all the shareholders.
- The HMRC would prefer that all dividends were paid out and not waived.
Speak to your accountant
HMRC states that not all dividend waivers are liable to challenge.
There are situations where the Settlements Legislation may apply, for example if the level of retained profits would not allow the rate of dividends to be paid to all shareholders, were the waiver not in place, or if there was evidence that a dividend was waived for tax avoidance reasons.
Speak to your accountant about wording a formal deed to waive your dividends. Your accountant can draw up documentation to legitimate your dividend waiver. But again, this is not something you should use regularly to retain company profits.
An alternative approach (to a dividend waiver), is to have different classes of shares (for example, ordinary A, ordinary B) and pay dividends only on one class of share, but again you need to be careful if you have already issued shares in the company.
Talk to your accountant about the best way to handle this for your individual circumstances.