Using dividend waivers effectively
Using dividend waivers effectively can prove very useful for some owner managed companies. So this article discusses the circumstances in which they might be used effectively and the pitfalls to avoid.
What are dividend waivers?
Where a company is using dividend waivers it means one or more shareholders are foregoing or ‘waiving’ their right to a dividend. However, dividends are paid out at a fixed rate per share. As a result, every shareholder is entitled to be paid in proportion to the number of shares they hold.
A dividend waiver can apply to a specified period or indefinitely. Although we would not recommend the latter approach for reasons discussed later.
Example 1
Jethro has 50 shares in Gibbs Ltd. Whereas Tony and Ziva the other directors both have 25 shares each. The directors propose to pay a dividend of £750 each. This would mean that Jethro would receive a dividend of £37,500. Whereas Tony and Ziva would receive a dividend of £18,750 each.
However, Jethro does not need the £37,500 and would be happier for the funds to remain in the company. Jethro would prefer his dividend is waived.
If he waives his dividend correctly, Jethro will receive nothing, but Tony and Ziva will receive their dividends as normal.
When is using dividend waivers appropriate?
In family companies, dividends are often waived where the shareholder doesn’t need the money. This is because they may be concerned about dividend taxes., or the company needs the funds for working capital. Obviously HMRC would usually prefer that the dividends were paid.
Tax issues involving dividend waivers
HMRC are less concerned about dividend waivers involving unrelated third party shareholders than those between connected parties. This is because it is difficult to demonstrate how an unrelated third party might benefit from a dividend waiver.
However HMRC will attack situations where the shareholders are spouses (or civil partners) and the following applies:
Example 2
Niles and Daphne have 50 shares each in Crane Ltd. Niles is a higher rate taxpayer whereas Daphne has no other earnings. The company has distributable profits of £40,000 available.
A dividend of £800 per share is declared, though Niles waives his right to a dividend and Daphne receives a dividend of £40,000.
It possible that HMRC may invoke the Settlements legislation as an anti avoidance measure arguing that the 50% of the dividend was diverted to Daphne though should be taxed on Niles. This is because Daphne is only a basic rate taxpayer paying tax at 8,25% on the dividend, whereas Niles would pay 33.75% on any dividends received
We would recommended that waivers last no more than twelve months. This is because a long-term waiver could reduce the value of your shareholding, What's more, it could even potentially increase the value of those shareholdings able to enjoy higher dividends as a result of the waiver.
Waivers in practice
Waivers are usually quite simple documents. They state the shareholder irrevocably waives their entitlement to dividends on specified shares in a specified company. Additionally they detail how long the waiver will last.
The shareholder can specify only a proportion of their shareholding is to be waived. This enables them to receive some, but not all, of the dividend they would otherwise receive.
While the dividend waiver is active, any dividends voted will be paid out as normal to non-waived shareholdings, while the waived shares are ignored.
The procedure
Because the waiver is a formal deed it must be signed and witnessed. Additionally, it must be executed before the entitlement to any dividend arises.
This is because you can't give away (and avoid tax on) on something to which you are already entitled.
Finally it is important that the waiver is filed with the company's statutory records.
Summary
Dividend waivers are relatively straightforward devices that can stop dividends being paid. However, HMRC can use the settlements anti-avoidance legislation to treat some of the waived dividend as income ‘belonging’ to the person waiving entitlement,
This would be in circumstances where they can demonstrate that you still benefited from the money while less tax was paid overall. For example, where there are waivers in favour of spouses who pay tax at lower rates.
Alternatively you could issue different classes of shares, so that different shareholders hold different classes, on which different (or no) dividends are payable. Although this does not necessarily prevent HMRC arguing that there has been a settlement if, say, one class/shareholder never receives dividends, and there is no commercial reason why.
For more useful information, check out our Ebooks here.
And if you'd like to know how we can help you with all of this, or with anything else, feel free to give us a call on 01202 048696 or email us at [email protected].
Alternatively, please feel free to complete our Business Questionnaire here.