Alphabet shares – how do they work in a limited company?

Most small limited companies are set up with a single class of ordinary shares.

If there are two shareholders, they might own 50 ordinary shares each, giving them an equal share of the company and, usually, an equal entitlement to dividends.

This is perfectly adequate for many businesses. But what if the shareholders don’t always want to receive the same dividend?

One option is to create different classes of ordinary shares – commonly known as alphabet shares.

As the name suggests, these are typically called A shares, B shares, C shares and so on.

They can give a small company more flexibility over how dividends are paid, although there are some important tax and company law considerations to bear in mind.

What are alphabet shares?

There is nothing particularly special about an A share or a B share.

They are simply separate classes of shares, with the rights attached to each class set out in the company’s articles.

For example, a company might have 50 A ordinary shares and 50 B ordinary shares.

Both classes could have exactly the same voting and capital rights, but separate rights to dividends.

Alternatively, one class might have different voting rights, or different rights to the company’s assets if it is wound up.

The letters themselves don’t mean anything. It is the rights attached to the shares which matter.

Why use alphabet shares?

The main reason in a typical owner-managed company is to provide some flexibility over dividends.

If two shareholders each own 50 ordinary shares of the same class, a dividend of £100 per share would normally mean that each receives £5,000.

You can’t simply decide that one shareholder will receive £7,000 and the other £3,000 if their shares carry identical rights.

With properly created A and B shares, it may be possible to declare a dividend on one class without declaring the same dividend on the other.

So, if one director owns the A shares and another owns the B shares, the company may be able to pay different dividends to each.

This is particularly relevant to husband-and-wife companies and other family businesses, although this is also where the tax rules need to be considered carefully.

Can you pay different dividends on A and B shares?

Yes, provided the share rights allow you to do so.

This is the important bit.

Simply calling one holding “A shares” and another “B shares” does not automatically give the company the right to pay different dividends.

The articles and share rights need to provide for separate dividends on each class.

And, as with any dividend, the company must have sufficient distributable profits available to make the payment.

The dividend should also be properly declared and recorded in the company’s paperwork.

Companies House also explains that different classes of shares can carry different rights, including voting and dividend rights, in its guidance for limited companies.

What about tax?

Alphabet shares are perfectly legitimate, but HMRC may take an interest where different share classes are being used mainly to divert income to somebody who pays less tax.

For example, suppose one spouse generates most of a company’s income, while the company regularly uses different share classes to direct most of the dividends to the other spouse because they pay tax at a lower rate.

HMRC’s settlements legislation may need to be considered in this type of arrangement.

HMRC specifically lists differing classes of shares which allow dividends to be paid only to lower-tax shareholders as one of the circumstances it may look at in its Trusts, Settlements and Estates Manual.

That doesn’t mean that paying different dividends on alphabet shares automatically causes a tax problem.

The facts matter, including how the shares were acquired, the rights they carry and the reason for the arrangement.

There are also specific rules relating to shares transferred between spouses and civil partners, so this is an area where it is worth taking advice rather than assuming that an alphabet share structure is automatically tax-efficient.

Alphabet shares versus dividend waivers

Another option small companies sometimes use is a dividend waiver.

This is where a shareholder gives up their entitlement to a particular dividend.

For example, two shareholders might own the same class of ordinary shares, but one waives their dividend so that only the other receives a payment.

Once again, be cautious when considering waiving a dividend.

HMRC can apply the settlements rules to dividend waiver arrangements, particularly where a waiver allows a spouse or other family member to receive a larger dividend than would otherwise have been possible.

HMRC gives further examples of the circumstances in which dividend waivers may be caught by the rules in its settlements guidance.

If a company genuinely needs the ability to pay different dividends to different shareholders on a regular basis, separate share classes may be more appropriate than relying on repeated dividend waivers.

Can an existing company create alphabet shares?

Yes. You don’t have to create alphabet shares when the company is first formed.

However, changing an existing share structure needs to be done properly.

Depending on how the company is currently set up, this could involve changing the articles, creating or redesignating classes of shares, passing shareholder resolutions and notifying Companies House.

If the rights attached to an existing class are being changed, the rules on varying class rights also need to be followed.

The Companies Act 2006 sets out the basic rules governing variations of class rights.

Companies House provides several forms for share changes, including SH08 where the name or designation of a share class changes and SH10 where rights attached to shares are varied.

The exact procedure depends on what you are actually changing, so this isn’t something to do by simply editing the company’s share register.

Are alphabet shares worth having?

If you are the company’s only shareholder, there is usually little point.

Even with two shareholders, a single class of ordinary shares may be all you need if dividends will always be paid in the same proportions.

Alphabet shares become more useful where a company has several shareholders and there is a genuine reason why their dividend, voting or capital rights need to differ.

They can provide useful flexibility, but they also make the company’s share structure more complicated.

For most small companies, it is worth discussing the proposed arrangement with an accountant or tax adviser before creating new classes of shares – particularly where the main reason for doing so is to pay different dividends to members of the same family.