You and your spouse are considering issuing so-called alphabet shares in your newly formed company. You’ve heard that HMRC doesn’t approve of these but can it legitimately prevent you from using them to save tax?

Tax efficiency

As a rule of thumb, the most tax-efficient method of taking profits from a company is dividends. However, in any company there can be reasons to pay some shareholders less than others, say to reflect their seniority. This can be achieved by issuing different types (classes) of share so that different rates of dividend can be paid. These are sometimes referred to as alphabet shares. If the shareholders aren’t connected, other than through the company, HMRC won’t have a problem with this, but it may take a tough stance where the shareholders involved are family.

Anti-avoidance rules

The so-called “settlements legislation” prevents a tax advantage resulting from one family member diverting their income to another. Where this involves spouses or civil partners, diverted income that’s caught by the settlements rules remains taxable on the spouse who diverted it.

Tip. These rules don’t apply if the asset, and not just the income it produces, is given by one spouse to the other. For company shares, this point was decided conclusively by the House of Lords in the “Arctic Systems” case . You can’t escape the settlements legislation entirely where the intention is to pay different rates of dividend to each spouse, and perhaps at different times.

Example. Bill, the sole director shareholder of Acom Ltd, is a higher rate taxpayer while his wife, Jean, only has variable profit from her self-employment, typically between £10,000 and £30,000. Bill wants to divert some of his dividend income to Jean to use her dividend nil rate band and basic rate band. He could do this by giving her some of his shares in Acom, but that would mean she would be entitled to the same rate of dividend as him each time one is declared. The trouble with this is that, when Jean makes a good profit, adding dividends may push her into the higher rate tax band, which defeats the purpose of diverting the income.

Alphabet shares

The solution to Bill and Jean’s tax conundrum is for Acom to issue a new class of shares to Jean. These would have identical rights as Bill’s shares, but would be called, say, “ordinary A shares” instead of Bill’s plain ordinary shares. Acom can then pay different rates of dividend at different times for each class of share.

Trap. While it’s trickier for HMRC to do so, it may still attack the arrangement as unfair avoidance if the rate of dividend paid on one class of share precludes an equal rate of dividend on the other. For example, say Bill owned 100 ordinary shares in Acom, Jean owned 50 A shares, and Acom had enough profits to pay a total of £100,000 dividends. If Bill took a dividend of £750 per share, Jean could not be paid the same rate of dividend on her shares because that would give a total of £112,500, which exceeds the available profit.

Tip. It’s OK to use alphabet shares to split dividends between spouses to save tax. But to avoid trouble with HMRC pay them at a rate which if applied to all classes of share would not exceed the amount of profit available.

This article has been reproduced by kind permission of Indicator – FL Memo Ltd. For details of their tax-saving products please visit or call 01233 653500.