Kevin Read outlines some of the problems and practicalities associated with dividend waivers.
If used correctly by a director/shareholder, dividend waivers can be a very effective planning tool; but there are several points that need careful consideration.
Is that ‘settled’?
For example, if a company’s shares are held by three directors who are family members, and one of them waives his dividend, the waiver is unlikely to be subject to challenge if the other shareholders are receiving no more than if there had been no waiver.
However, if this is not the case (i.e. the full dividend before waiver is more than the distributable profits), one shareholder waiving the dividend may allow others to receive excess dividends.
Example: Excessive waiver?
Jacob, Boris, and Steve own respectively 20%, 40%, and 40% of ERG Ltd, which has 100 shares in issue and distributable profits of £110,000. Steve waives his dividend and the company declares a dividend of £150 per share.
Jacob receives £30,000 and Boris £60,000. However, had there been no dividend waiver and a full distribution of distributable reserves, they would have received, respectively, £22,000 and £44,000. Steve’s waiver has, therefore, created ‘bounty’ for them of £8,000 and £16,000 respectively.
HMRC can attack such an arrangement under the settlements legislation (ITA 2007, s 626), where there is ‘an arrangement’ to create bounty for another person. If successful, they will be able to tax the excess amounts (totalling £24,000 here) on Steve rather than Jacob and Boris. In practice, HMRC is only likely to take this route where the waiver is considered to create a tax advantage (e.g. if Steve is a top rate taxpayer and the others are not).
Note that the settlements legislation provides an exemption for inter-spousal bounty, but that exception does not apply if it is merely a gift of income; hence it is not applicable to dividend waiver arrangements.
In Donovan & McLaren v HMRC [2014] UKFTT 048 (TC), a series of waivers by two sets of husband and wife shareholders, with a view to equalising dividends paid and allowing the wives to utilise their basic rate bands, was held not to work.
In Buck v R & C Commrs (2008) SpC 716, the husband waiving his dividend enabled his wife to receive a dividend of £35,000 for two successive years. The fact that this was an ‘arrangement’ was evident from the fact that this small company would have needed annual profits of over £300 million for the wife to receive that level of dividend had there been no waiver!
Don’t forget the formalities
With regard to legal formalities, it is often overlooked that a formal deed of waiver is required, which must be signed, dated, witnessed, and lodged with the company. The need to be executed as a deed makes their drafting a reserved activity, which only a member of The Law Society or the Bar can conduct. It cannot, for example, be done just by shareholder letter.
The waiver must be done before the right to the dividend arises because a waiver after payment is a transfer of income, which constitutes a settlement.
If justifiable, it is best to state in the deed that the waiver has been made to allow the company to retain funds for a specific purpose, thus emphasising that there is some commercial reason for the waiver. This may provide some defence should HMRC choose to challenge its effectiveness.
‘Alphabet share’ arrangements, where different dividends can be paid on different classes of share, negate the need for waivers, but can produce their own tax issues.
Practical Tip:
Make sure that there is a commercial reason for a dividend waiver and that the waiver is effected under deed.
