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Dividend waivers: Get the details right

Dividend Waivers Key Points

  • A dividend waiver can bring flexibility to profit distributions
  • Shareholder can voluntarily waive their entitlement to a share of the dividend
  • HMRC’s approach can be inconsistent and there are traps for the unwary
  • Use waivers sparingly, and ensure a commercial reason is documented

 

When to use a dividend waiver

Dividends are paid at the same rate for each category of share in accordance with the number of shareholdings held. Such inflexibility could mean the distribution of profits not being made in the most tax efficient manner or produce difficulties for a shareholder who does not want or need the payment - a dividend waiver may offer the solution.
 

How it works

The shareholder voluntarily waives entitlement to their share of the dividend, allowing the distributable profits to be divided between the remaining shareholders in the proportion of their holdings.
Scenario 1
ABC Ltd has distributable profits of £50,000 and wants to pay a dividend of £400
per share; the shares are held by three brothers as follows:
A         50 shares
B         25 shares
C         25 shares
 
A can waive his dividend and B and C will receive £10,000 each with no matters arising; A’s dividend remains within in the company.
Scenario 2
Same details as above with A waiving his dividend but B and C receiving an increased amount of £15,000 each (£600 per share). HMRC may challenge this waiver contending that A has settled £2,500 on each of his brothers and he will be taxed thereon on the grounds that an element of bounty is present. Although the actual total amount of dividend paid (£30,000) is less than the amount of distributable profit (£50,000), if A had not waived his dividend the company would not have had enough distributable profits to pay the increased £600 per share (£600 x 100 = £60,000).
 

When will HMRC become interested?

  • In practice HMRC are only likely to take the above settlement point where the waiver is considered to create a tax advantage.
  •  They will try to argue that the waiver indirectly provided funds for an ‘arrangement’ or ‘settlement’ under Income Tax (Trading and Other Income) Act 2005 Pt 5 Chpt 5 s623; an element of bounty being needed for the settlement provisions to apply.
  • If the transfer is between spouses HMRC will deem the settlement to be one of income and unless there is an outright transfer/gift of ownership of the shares
  • Specific points

    1. A formal deed of waiver is required, which must be signed, dated, witnessed and lodged with the company
    2. It is imperative that the waiver be in place before the right to the dividend arises because a waiver after payment is a transfer of income which constitutes a settlement. Therefore an interim dividend must be waived before being paid; a final dividend is payable once approved at an AGM unless confirmed to be payable at a future set date.
    3. HMRC would prefer to see a commercial reason for the waiver. Therefore, best to state in the deed that the waiver has been made to allow the company to retain funds for a specific purpose.
    4. Dividend waivers should be used sparingly - don’t waive every year. HMRC will look more closely at arrangements which are repeated, the practical effect of which reduces the overall tax payable.
    5. Nothing should be given in consideration of the waiver.
    6. A waiver may cover a single dividend, a series of dividends or dividends declared during a specified period of time.
    7. Ensure that the dividend declared per share times the number of shares in issue does not exceed the amount of the company’s distributable reserves (see scenario 2 above).

    Are there any other options?

    1. The shareholder who does not want the dividend will have to transfer his shares to another shareholder(s) before the dividend is declared. This will mean no further involvement in the company and would be more difficult to reissue shares to him at a later date; the procedure also needs Board approval.
    2. Re-categorise the shares into A and B shares with the same rights except for dividends; then declare a dividend on the A share only. The owner of the B –type shares will not receive dividends for the time being but remains involved with the company.

    Final Note

    A waiver of dividends will not be chargeable to IHT as a transfer of value if made within 12 months before the right to the dividend arises.

    Posted on Thursday 24th February 2011 by Chris Skelding

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