When your company declares a dividend, the proceeds must be split equitably, according to the number of shares each shareholder owns at the time. In some cases, it may be possible for one or several shareholders to ‘waive’ their rights to receive a dividend. Here we look at what dividend waivers involve, and why you should be aware of the tax implications should they be used improperly.
What is a dividend waiver?
If one more shareholders decide to waive their rights to receive a dividend, a number of procedures must be followed, to avoid the distribution being challenged by HMRC.
- Firstly, a Deed of Waiver must be formally executed and signed by shareholders who would otherwise be entitled to receive the share income. It must be witnessed and returned to the company. You can view a basic sample template below.
- The waiver must be in place before the right to receive a dividend arises (in the case of an interim dividend, this must be on a date before it is paid).
- A waiver should typically be used only for genuine commercial reasons.
- A waiver must not create a situation where the resultant dividend is deemed to be a ‘settlement’ (i.e. used for tax avoidance reasons).
Are there valid commercial reasons for the waiver?
As limited company owners will know, dividends are taxed at a lower rate than employment income – mainly because National Insurance Contributions are not payable on dividends, as they are on salaries.
If some of the company’s employees are also shareholders in the company, some shareholders may waive their rights to receive a dividend, to enable the employee-shareholders to be remunerated via larger dividends – in lieu of salary.
This type of arrangement could be challenged by HMRC, as the decision to waive dividends would be purely to avoid tax, rather than for a valid commercial reason. If successfully challenged, the additional dividend funds received by these employee-shareholders would subsequently be taxed as employment income.
So, ideally, a valid commercial reason for the waiver, such as enabling the company to retain funds for a specific purpose, needs to be in place and documented.
Is the dividend a ‘settlement’?
Another significant obstacle lying in the path of company owners who wish to waive dividends is the Settlements Legislation.
Many small companies are owned by two shareholders – often a husband and wife. Dividend waivers are sometimes used to make use of one shareholder’s lower rate of tax, giving rise to a settlement of income.
If one shareholder decides to waive his or her rights to receive a dividend, you must ensure that the dividend received by the other shareholder is not deemed to be a ‘settlement’ by HMRC. The taxman will consider the following questions if your tax affairs are reviewed:
- If the waiver were not in place, would there have been sufficient retained profits in the company to pay the same dividend rate to all shareholders?
- Does the company have a history of dividend waivers? Over a period of time – across more than the current financial year, if no dividends had been waived, would the company have been able to pay the same rate of dividend to all shareholders from the combined retained profit for all years?
- Would the recipient benefit financially from the arrangement, and would the waiving shareholder reasonably be aware of this?
For example, say a husband and wife own a company in a 75:25 split, and make a profit of £58,000 during the financial year. The husband waives his right to take a dividend, and the company declares a dividend of £2,000 per share. Here, the wife will receive a dividend of £50,000, leaving £8,000 profits in the company.
This arrangement could be successfully challenged by HMRC, as the company would not be able to distribute the dividend at the £2,000 rate to both shareholders if the dividend waiver had not been used.
Find out more in HMRC TSEM4225 – situations where the Settlements Legislation will apply.
Recent cases involving dividend waivers
A fairly recent high profile First-tier tribunal case – Donovan & McLaren vs. HMRC – highlights the importance of taking professional advice before using dividend waivers.
In this case, two directors of a company used multiple dividend waivers to enable their wives to make use of their basic tax bands, rather than the directors’ higher rate bands.
The directors owned 80% of the company, and the wives 20%.
The directors waived their rights to receive dividends several times over three years, and after losing their appeal were told to repay £27,000 each in back taxes.
The judge decided that the waivers were used purely to lower the aggregate tax liabilities of each couple, not for any valid commercial reasons.
Another case (Buck v HMRC) demonstrates why the company has to have sufficient reserves in place to facilitate payment to all shareholders had the waiver not been put in place.
In this case, Mr Buck, who owned 9,999 shares in his company, waived his right to a dividend for the year ending March 2000 and distributed £35,000 to his wife, who owned a single share. Clearly, the company would have been unable to pay this amount to all shareholder, had the waiver not been in place. In fact, the company would have needed over £300m in retained profit to achieve this. In this case, the special commissioner concluded that the distribution was a ‘settlement’ and should be taxed accordingly.
Dividend waiver template
A shareholder may decide to waive his rights to a single dividend distribution, or to all dividends declared within a financial year, or indefinitely. Your accountant should be able to provide you with the specific wording for your needs.
An example template – to waive rights to a single dividend – would look like this.
WAIVER OF DIVIDEND
I, [NAME] of [ADDRESS], the registered holder of [NUMBER OF SHARES] Ordinary Shares of [£x] each in the capital of [COMPANY NAME] (the Company), hereby waive all rights to payment of the [INTERIM / FINAL] dividend of [£X] per share declared by the Company and its directors on [DECLARATION DATE] in respect of the year ended [YEAR-END DATE].
One possible solution would be to use different share classes – with dividend rights only applying to one class. So, some shareholders would receive dividends (Class A), but others (Class B) would still own part of the company, but wouldn’t be entitled to receive income.
Alternatively, might you benefit from having a more equitable share structure if you co-own the company with your spouse (i.e. a 50:50 or 60:40 share split, rather than the startling 9999:1 split in the case of Buck v HMRC referred to above)!
Clearly, you should seek professional advice for all matters related to the share structure of your company, and specifically whether or not you should consider using a dividend waiver.