THE USE OF so-called Alphabet shares has been a staple in the world of tax planning for some time. These types of shares generally allow for a flexible approach to how dividends are paid out to shareholders of a company, enabling a tailored distribution that can be adjusted according to the individual tax circumstances of the shareholders.
In today’s Shipleys Tax brief, we will cover the basic concept of Alphabet shares, their benefits and drawbacks, and the likely approach adopted by HMRC to their use.
What are Alphabet shares?
Alphabet shares are so named because they categorize shares into different classes, each denoted by a letter of the alphabet (e.g., Class A shares, Class B shares, etc.). This classification allows companies to assign different rights to each class, particularly concerning dividend payments. The flexibility in dividend allocation means that shareholders can be paid varying amounts, which can be adjusted to optimise their personal tax positions.
What are they used for?
Historically, Alphabet shares have been used as a popular method for family-run businesses to manage internal dynamics and tax liabilities. Families could allocate different dividend rights to members based on their involvement in the business or their financial needs, without altering the overall control or structure of the company.
They have also been employed in start-ups and growing businesses looking to reward key employees with a stake in the company without immediately giving away voting rights or an equal share in the distribution of profits. By issuing different classes of shares to employees, businesses could align staff interests with the company’s performance without giving away significant control.
Families could allocate different dividend rights to members based on their involvement in the business or their financial needs, without altering the overall control or structure of the company.
In corporate fundraising they provided a means to attract investment by offering variable dividend rights while retaining management control. This aspect is particularly attractive to small and medium-sized enterprises (SMEs) that are keen on securing capital but wary of outside influence over business decisions.
This flexibility makes Alphabet shares a valuable instrument for companies to structure their equity in a way that satisfied a multitude of shareholder requirements.
Tax Planning and Tailoring to Specific Needs
For certain commercial transactions, tax planning with Alphabet shares can be particularly useful in the right circumstances. Generally, you would find the following potential benefits:
– Minimise personal tax liability: shareholders can receive dividends up to the higher-rate tax threshold, effectively reducing their income tax liability.
– Utilise allowances and rates: shareholders can make full use of their dividend allowance and lower tax bands.
Minimise personal tax liability: shareholders can receive dividends up to the higher-rate tax threshold, effectively reducing their income tax liability.
– Planning for succession: Different classes can be allocated to future generations for long-term planning, without disrupting the current control of the company.
– Family estate planning: Alphabet shares can help in assigning income to family members in lower tax brackets where circumstances allow.
Not all a bed of roses…
While Alphabet shares offer flexibility as seen above, they come with a rack of potential drawbacks that can complicate their use.
– Administrative Burden: maintaining different classes of shares requires meticulous record-keeping and administrative oversight. Each class may have its own dividend schedules, voting rights, and restrictions, which must be managed and documented appropriately.
– Legal Challenges: alphabet shares can sometimes lead to legal challenges, especially if shareholders feel their rights are being impinged upon. Disputes may arise over the interpretation of rights attached to various classes, or if there are allegations of unfair treatment among shareholders.
– Corporate Governance: having multiple share classes can complicate corporate governance. The differing rights and privileges can lead to conflicts of interest and make decision-making processes more complex.
What sayeth the Taxman?
HMRC views Alphabet shares with a healthy degree of suspicion because they can be used to artificially manipulate income streams for tax advantages. One specific piece of anti-avoidance legislation (“the settlements legislation”) can apply if HMRC believes that Alphabet shares are being used to divert income to someone else and reduce tax liability.
In the context of family businesses, the use of Alphabet shares for estate planning must be done with caution. HMRC may challenge arrangements that appear to be designed to avoid inheritance tax, particularly if shares are rapidly transferred between family members in a way that seems to be timed to minimise tax liability for example.
HMRC views Alphabet shares with a healthy degree of suspicion because they can be used to artificially manipulate income streams for tax advantages.
As such, if not structured correctly, the arrangements can be easily challenged under these anti-avoidance regulations, leading to the tax advantages being negated, tax investigations and potential penalties.
Conclusion
Alphabet shares can be a useful tool for tax planning when used correctly. They allow for a high degree of flexibility and can be tailored to meet the specific needs of both the company and its shareholders. However, their use must be considered carefully, with a clear understanding of the potential pitfalls and the close scrutiny they attract from HMRC. As always, when considering the use of Alphabet shares, it is prudent to seek professional advice to ensure that they are implemented effectively.
For further assistance or queries, please call 0114 272 4984 or email info@shipleystax.com.
Please note that Shipleys Tax do not give free advice by email or telephone. The content of this article is for general guidance only and should not be considered as tax or professional advice. Always consult with a qualified professional before taking any action.
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