When a 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. improperly.
Here we look at what dividend waivers are, and why you should be aware of the tax implications should they be used
What is a dividend waiver?
To prevent HMRC from challenging a dividend distribution, you should follow certain steps if one or more shareholders choose to waive their right to receive a dividend.
- Formally execute a Deed of Waiver, signed by shareholders who would otherwise be entitled to receive the share income.
- The deed must be witnessed and returned to the company. You can view a basic sample template below.
- It is essential to have the waiver in place before the right to receive a dividend arises, particularly for interim dividends.
Remember that waiver should only be used for legitimate commercial reasons and must not create a situation where the resulting dividend is deemed to be a ‘settlement’ used for tax avoidance purposes.
Are there valid commercial reasons for the waiver?
Dividends are subject to lower tax rates than PAYE employment income, although this gap has significantly reduced in recent years.
In cases where employees of the company are also shareholders, some may choose to waive their dividend rights, allowing other employee-shareholders to receive larger dividends instead of a salary.
However, this type of arrangement may be contested by HMRC if the waiver decision is solely to avoid taxes rather than for a legitimate commercial reason.
If challenged by HMRC, the extra dividends received by employee-shareholders will be taxed as employment income.
Therefore, you should always have a valid commercial reason for a waiver, such as retaining funds for a specific purpose, and document it to avoid potential issues.
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.
Things to bear in mind to avoid a deemed ‘settlement’
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?
An example where a dividend waiver may be challenged
For example, 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 retained profits in the company.
HMRC could successfully challenge this arrangement, 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
Donovan & McLaren vs. HMRC – avoiding tax
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.
Buck vs. HMRC – insufficient reserves in place
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 shareholders, 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].
[DATE]
Signed by:
[SIGNATURE]
Witnessed by:
[SIGNATURE]
[NAME]
[ADDRESS]
Some alternatives to dividend waivers
One possible solution is to use different share classes – with dividend rights only applying to one class.
So, some shareholders receive dividends (Class A), but others (Class B) still own part of the company but are not entitled to receive income.
Alternatively, you may benefit from having a more equitable share structure if you co-own the company with your spouse.
The company shares might be split 50:50 or 60:40, rather than the startling 9999:1 split in the case of Buck v HMRC referred to above)!
You should seek professional advice for all matters related to the share structure of your company, specifically whether or not you should consider using a dividend waiver.
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