In this guide, Ercan Demiralay, partner at accountancy firm Wellers, discusses the principles of limited company dividends, what a dividend waiver is, and how HMRC views them.
How do dividend distributions work?
Directors of limited companies will be well aware of the process of dividends, in that these are payments made to shareholders from cumulative profits of a limited company.
This means that a company can only pay dividends to shareholders if it has sufficient profits after tax to date.
It is illegal to pay out dividends if the company doesn’t have sufficient profits to do so.
However, if the company is profitable, profits can be accumulated over many years in a limited company (known as ‘retained profits’).
Dividends can be distributed to shareholders throughout the year to allow for easier cash flow management and ensure the company does not pay out cash that would impact its working capital requirements.
Within this mix, there is also the concept of the ‘dividend waiver’.
Certain shareholders of smaller companies, in particular, may choose to waive their dividend entitlements in order to retain money in the business.
The other shareholders can still choose to receive their proportion of declared dividends, but those that waive their dividend will receive nothing — their share of the profits remain in the company’s bank account.
Business owners should also be aware of ‘settlements rules’.
These act as anti-avoidance provisions to prevent business owners paying assets (dividends) to their spouse whilst they lower their wage to limit tax liabilities.
In this instance, the settlor (i.e. the business owner) retains an interest in the asset (dividends) given away and the settlor benefits from the gifted asset because it was paid to their spouse.
The transfer of dividends in this way can be deemed a transfer of value for inheritance tax purposes and even ‘value-shifting’ for income and capital gains tax purposes by HMRC.
Read more about HMRC’s stance in TSEM4225.
The HMRC Challenge
Dividend waivers challenged by HMRC are invariably the result of payments made that increase the dividends amount for a company owner’s spouse (or children, or the trustees of a children’s settlement).
In practice, HMRC are only likely to make the ‘settlements’ point where the waiver is considered to create a tax advantage.
HMRC takes particular interest if the level of retained profits in the company is insufficient to allow the same rate of dividend to be paid on all issued share capital, or where there is evidence which suggests that the same rate could not have been paid on all the issued shares in the absence of the waiver.
To prevent a HMRC investigation, the deed should note that the waiver allows the company to retain funds for a specific purpose, emphasising there is some commercial reasoning behind the decision.
Consider the options
- Dividend waivers should be used very sparingly. HMRC will look more closely at repeated arrangements, the practical effect of which reduces the overall tax payable.
- Waivers should also not last for more than one year. The use of a long-term waiver could reduce the value of the shareholding.
- If waivers are required more regularly, then business owners should seek advice from their accountant on the various types of shares, and specifically the creation of ‘Alphabet shares’.
- A Dividend waiver must be a formal deed, signed, dated, witnessed, and sent to the company.
- The drafting of a deed is a reserved activity, which only a member of The Law Society or the Bar can conduct.
- Before seeking a Dividend waiver, always seek professional advice from an accountant to understand the potential tax implications in full.
Wellers is one of the UK’s leading mid-tier accountancy firms, which specialises in advising SME owner managed businesses. Visit their website to find out more about dividends and how to use them.