With the introduction of the dividends allowance of £5,000 on 6 April 2016 (which subsequently dropped to £2,000 on 6 April 2018) more and more accountancy firms have been suggesting issuing a director’s spouse with an ‘A’ ordinary share in order to pay dividends on a flexible basis (without regard to shareholding percentages) and to make use of the spouse’s tax-free dividend allowance.
Fully-fledged alphabet shares conferring all the normal legal rights (e.g. a right to vote at meetings, a right to appoint/remove directors, a right to receive capital distributions on sale of shares or winding up, and a right to dividends) appear to comply with the most famous ‘income shifting’ case (Arctic Systems vs. HMRC).
Although HMRC won the settlements legislation piece of this ‘income shifting’ case, HMRC ultimately lost the entire case against Mr Jones (an IT contractor) as the shares that Mr Jones gifted his wife conferred all the legal rights and therefore were not just “wholly and substantially a right to income”.
In addition, protection from an HMRC challenge also comes from Section 421B of ITEPA 2003 that allows shares to be gifted in the normal course of domestic family relationships.
However, a problem does arise where the accountant (or taxpayer if no accountant is involved) has not complied with company law and issued the alphabet shares in direct contravention to the existing Articles of Association of the company.
In order for an alphabet share to be issued notices have to be issued, minutes recorded, resolutions passed and amended or enhanced Articles of Association submitted to Companies House.
Without the amended Articles being submitted to Companies House the company will not be allowed to create alphabet shares and therefore any dividends paid on alphabet shares are likely to be challenged by HMRC as void.
Almost all the users of alphabet shares that I am seeing have issued alphabet shares in their company despite it going against the original Articles of Association (as no amended Articles have been filed with Companies House).
This is likely going to cause a long term problem with HMRC as these alphabet shares are not allowed to exist without amended Articles being filed with Companies House.
If you are using alphabet shares in your company make sure that they have been issued correctly as this will make any dividends paid on these shares more difficult to challenge. Also, if reasonable care has not been taken when issuing shares this can extend the HMRC investigation window from 4 years to 6 years, giving HMRC an extra 2 years to issue tax assessments, penalties and interest.
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The above information is just for guidance purposes only and is not a substitute for professional advice and consulting the legislation.