Alphabet shares for family companies

The dividend allowance is reduced from £2,000 to £1,000 from 6 April 2023 and to £500 from 6 April 2024. Read this article to find out whether an alphabet share structure is still beneficial.

What are Alphabet shares

An alphabet share structure refers to a type of shareholding system where each shareholder holds a distinct class of share, such as A ordinary shares, B ordinary shares, or C ordinary shares. The advantage of this structure is that it allows for customized dividend payouts that take into account the individual circumstances of each shareholder. According to company law, dividends must be paid in proportion to the number of shares owned by each shareholder. However, an alphabet share structure can bypass this requirement, which makes it a popular choice for family-owned companies seeking more flexibility.

Using the dividend allowances

An alphabet share structure offers a key advantage in that it enables shareholders who work outside the family company to benefit from unused dividend allowances for a given tax year. This, in turn, increases the tax-free profits that can be extracted from the company. However, recent changes to the dividend allowance limit may hinder this strategy. For the 2022/23 tax year, the dividend allowance was set at £2,000, but it is scheduled to decrease to £1,000 in 2023/24 and £500 in 2024/25. As a result, a family company with four shareholders could previously extract up to £8,000 in tax-free profits by taking advantage of their dividend allowances in 2022/23. But this figure will be reduced to just £2,000 by 2024/25.

Despite the reduction in the dividend allowance and the subsequent decrease in potential tax-free profit extraction, implementing an alphabet share structure can still be advantageous if the shareholders have varying marginal tax rates. This structure allows for dividend payouts to be customized so that they are taxed at the lowest possible rate. In 2023/24, dividends are subject to a tax rate of 8.75% if they fall in the basic rate band, 33.75% if they fall in the higher rate band, and 39.35% if they fall in the additional rate band.

Example

Alan, Beth, and Charles are shareholders in ABC Ltd. Alan has 100 A ordinary shares, Beth has 100 B ordinary shares and Charles has 100 C ordinary shares.

For 2023/24 the company has profits of £45,000 that they wish to extract. Alan has another job and is an additional rate taxpayer. Beth has an income from property of £35,270 a year and Charles has an income of £20,270 from his part-time job. They all have their dividend allowance available.

To minimise the tax payable, the company declares a dividend of £10 per share for A ordinary shares, a dividend of £150 per share for B ordinary shares and a dividend of £290 per share for C ordinary shares.

Alan receives a dividend of £1,000. This is sheltered by his dividend allowance and is tax-free.

Beth receives a dividend of £15,000 of which £1,000 is sheltered by her dividend allowance and is tax-free. The remaining £14,000 is taxable at the dividend ordinary rate of 8.75% (a tax bill of £1,225), which uses up her remaining basic rate band.

Charles receives a dividend of £29,000 of which £1,000 is sheltered by his dividend allowance and received tax-free. The remaining £28,000 falls within his basic rate band and is taxed at 8.75% (a tax bill of £2,450).

The total tax bill is £3,675.

Had each taxpayer received a dividend of £15,000, the total tax bill would have been £7,959. Alan would pay tax on £14,000 of his dividend at 39.35% and Beth and Charles would each pay tax at 8.75% on £14,000 of their dividend. The remaining £1,000 of each dividend would be sheltered by the dividend allowance.

By having an alphabet share structure, they can tailor the dividends to reduce the total tax bill by £4,284.

Proceed with caution

Care needs to be taken when making changes to a company’s shareholding structure, as the unwary may fall foul of anti-avoidance tax rules. Distributing shares and dividends to children who are under 18 years old may result in taxable gross income exceeding £100, and because they are legally minors, their tax responsibility falls on their parents. Therefore, providing shares to children under 18 years old is not recommended if the goal is to minimize tax obligations. It is essential to carefully consider all tax planning strategies and seek legal guidance as needed while restructuring the company’s share capital. Contact us to speak with one of our tax experts.