Dividend waivers: Is there a better way?

Sarah Bradford looks at dividend waivers and considers possible alternatives.

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To comply with company law requirements, dividends must be paid out of retained profits, and must also be in proportion to shareholdings. This can be problematic if, for example, one or more shareholders do not want a dividend, or it would be more tax-efficient to pay a larger dividend to a particular shareholder to utilise their personal and dividend allowances and basic rate bands.  

This is where dividend waivers come into play. 

What is a dividend waiver? 

A dividend waiver is broadly where one or more shareholder gives up their right to a dividend. A dividend waiver can be in respect of a particular dividend, or for a set period, or open-ended.  

Shareholders wanting to waive a dividend must follow a formal process under company law. 

The first point to consider is timing and when the dividend needs to be waived. For a final dividend, the waiver must be in place before the right to receive the dividend arises; for an interim dividend, it must be done before the dividend is paid. 

The dividend is formally waived by deed of waiver. This must state the dividend being waived and must be signed by the shareholder and by a witness. The company should keep the dividend waiver on file. 

Use of dividend waivers 

Dividend waivers may be used in a family company situation as a tax planning device to reduce the overall tax bill on profits extracted from the company. Where a dividend is waived, the funds that would have been used remain in the company and are available for distribution to other shareholders. 

The following example illustrates the use of a dividend waiver in a family company. 

Example: Husband and wife company 

Anne and Alan are directors and shareholders in their family company A Ltd. They have each received a salary of £12,570 from the company and further profits are to be extracted as dividends.  

Anne’s only income is from the company. Alan also has rental income of £55,000. Anne and Alan each hold 50 ordinary shares. 

The company has retained profits of £32,000 that they wish to distribute as a dividend. The company initially declares an interim dividend of £20 per share. Anne and Alan each receive a dividend of £1,000, which is sheltered by their dividend allowance for 2023/24 (set at £1,000). After paying this dividend, the company has £30,000 of retained profits remaining that they wish to pay out as a dividend. 

Any further dividends received by Alan will be taxed at the dividend upper rate of 33.75%. However, Anne has £36,700 of her basic rate remaining, and dividends falling within this band will be taxed at the dividend ordinary rate of 8.75%. 

Ideally, the company would pay a dividend of £30,000 to Anne only. However, as they own the ordinary share capital equally, this cannot be done while complying with the company law requirement to pay dividends in proportion to shareholdings. 

To overcome this, the company declares a dividend of £600 per share. To pay this dividend, they would need retained profits of £60,000 (paying Anne and Alan each a dividend of £30,000 (50 shares @ £600 per share)). However, the company only has retained profits of £30,000. 

Alan waives his dividend. This means that the company does not have to pay him his dividend of £30,000, leaving sufficient funds to pay the dividend of £30,000 to Anne. It is taxed at the dividend ordinary rate of 8.75% – a tax bill of £2,625. 

Had Alan not waived his dividend and the company had instead declared a dividend of £300 per share to extract the profits of £30,000, Anne and Alan would each have received a dividend of £15,000 (50 shares @ £300 per share). Anne would have paid tax of £1,312.50 (£15,000 @8.75%) on her dividend and Alan would have paid tax of £5,062.50 (£15,000 @33.75%) on his dividend – a combined tax bill of £5,062.50. By taking the dividend waiver route, the couple save tax of £2,437.50. 

However, such a strategy is open to challenge by HMRC: See Dangers of waivers below. 

Dangers of waivers 

While at first sight, using dividend waivers in this way appears to overcome the company law requirement to pay dividends in proportion to shareholdings, it is an approach that is fraught with danger. 

Unsurprisingly, HMRC is not happy for dividend waivers to be used to transfer income from one partner to another to reduce the tax that is payable, and may mount a challenge under the ‘settlements’ provisions. Such an attack is more likely if the level of the retained profits is insufficient to allow a dividend of the same rate to be paid to all shareholders, as is the case in the example set out above (see HMRC’s Trusts Settlements and Estates manual at TSEM4225). Without the dividend waiver, the company would not have been able to pay a dividend of £600 per share to all shareholders as it does not have sufficient retained profits; dividends can only be paid out of retained profits.  

HMRC may also challenge a dividend waiver if: 

• the shareholder making the waiver wishes to benefit another shareholder (in the example, Alan waives his dividend to benefit Anne); 

• the shareholder who has not waived their dividend pays less tax on the dividend than would be paid by the shareholder waiving the dividend (in the example, Anne pays less tax on the dividend than Alan); and 

• there is a history of dividend waivers. 

HMRC will also look carefully at situations where the retained profits are sufficient to pay a dividend at the same rate to all shareholders because the retained profits have been boosted by a series of dividend waivers.  

HMRC is more likely to attack arrangements between spouses. Consequently, the message when using dividend waivers in family companies is to proceed with caution. That is not to say dividend waivers should not be used; but there should be sound commercial reasons for doing so, such as leaving funds in the company to fund capital investment. 

Alternative strategies 

It is possible to overcome the requirement to pay dividends in proportion to shareholdings by having an alphabet share structure. This allows different dividends to be declared for different classes of shares.  

If, in the above example, instead of Anne and Alan each owing 50% of the ordinary share capital, the company could have instead created two classes of shares – ‘A’ ordinary shares and ‘B’ ordinary shares. If Alan had, for example, held 100 ‘A’ ordinary shares and Anne had held 100 ‘B’ ordinary shares, the company could have simply declared a dividend of £300 per share for ‘B’ ordinary shareholders only, paying Anne a dividend of £30,000 (100 shares @£300 per share). As no dividend is declared for ‘A’ ordinary shareholders, Alan would not receive a dividend. The retained profits of £30,000 would be paid to Anne and taxed at the dividend ordinary rate of 8.75%. If this route is taken, the total tax payable on the dividend is £2,625 – the same as under the dividend waiver approach. 

While HMRC may also challenge this approach, setting up the company with an alphabet share structure from the outset reduces the risk of such a challenge. Shares can also be allocated to other family members to utilise their dividend allowances and unused basic rate bands, with each person having their own class of share. Commercial justification for an alphabet share structure will strengthen the case should HMRC raise questions. 

It should also be remembered that profits do not have to be extracted as dividends. Other extraction routes can be considered, such as providing benefits-in-kind, paying rent where the company is run from a home office, or by making pension contributions. The company can also opt to pay a bonus instead, but where a salary equal to the personal allowance has already been paid, tax and National Insurance contributions will be due.  

Practical tip  

While dividend waivers have their uses, they should be used with caution if the aim is to redistribute profits between shareholders to save tax. Consideration can instead be given to having an alphabet share structure to allow dividends to be tailored to the personal circumstances of the shareholders, without breaching the requirement to pay dividends in proportion to shareholdings.