Dividend waivers: what do you need to consider?

Henry Catchpole explains how dividend waivers work, and the steps to take to avoid having them challenged by the taxman.

Your business has had a successful year and you want to reward your shareholders by giving a dividend. But what’s the situation if not everyone wants to take it?

There are several reasons why shareholders may wish to create a dividend waiver. In the past, particularly in family companies, it was quite common for some shareholders to waive dividends to increase the dividend pot available for others. Alternatively, while some family members would take their dividends, others would waive the dividend to retain some profit within the business to fund future growth.

HMRC is now increasingly keen that there are valid commercial reasons for the dividend waiver. It’s therefore particularly important to take real care to ensure you don’t run the risk of a dividend waiver being challenged by HMRC.



Deed of Waiver form

If your shareholders decide to waive dividends, there is a formal process you need to follow to ensure that the required records are kept.

For final dividends, the waiver must be decided and in place before the right to receive a dividend arises. For interim dividends it must be in place before the dividend is paid.

A Deed of Waiver is required for all shareholders waiving their dividend; they need to be signed by the shareholder, witnessed and returned to the company.

The waiver may be for a set period or may be open-ended.

 

What is HMRC’s view?

There need to be sound commercial reasons for waiving a dividend. If HMRC suspects that the dividend waiver is being used simply to avoid tax, then it is likely to ask questions.

As well as being taxed at a lower rate than employment income, dividend payments are exempt from a requirement to pay national insurance contributions. The directors of a company may choose to reward their staff through payment of a dividend but waive their own dividend to increase the size of the dividend pot. However, if HMRC suspects that the dividend is being made in lieu of salary, it may take the view that the dividend should be taxed at the employment rate.

Also, HMRC may test the dividend arrangement against the settlements legislation, which is likely to apply if:

  • The level of retained profits, including those of subsidiary companies, is insufficient to allow the same rate of dividend to be paid on all issued share capital.
  • Although there are sufficient retained profits to pay the same rate of dividend per share for that particular year, there has been a run of waivers over a number of years where the total dividends payable in the absence of the waivers exceed accumulated realised profits.
  • There is any other evidence which suggests that the same rate would not have been paid on all the issued shares in the absence of a waiver.
  • The non-waiving shareholders are persons whom the waiving shareholder can reasonably be regarded as wishing to benefit from the waiver.
  • The non-waiving shareholder would pay less tax on the dividend than the waiving shareholder.



Married couples

There are legal precedents where companies owned by married couples have used a dividend waiver to pay the party who is in a lower tax band a greater proportion of the profits.

Here’s an illustration. Mr and Mrs Smith run a property management business, Mrs Smith with 80 shares and Mr Smith with 20. Mrs Smith waives her right to any dividend. Having made a profit of £3,000 they decide to pay a dividend of £100 per share and Mr Smith receives a dividend of £2,000.

In this example HMRC is likely to use the settlements legislation to challenge the payment as the company would be unable to pay the same rate of dividend to all shareholders if Mrs Smith had not waived her right to the dividend. In addition, Mr Smith, as the non-waiving shareholder, is someone Mrs Smith would wish to benefit from the waiver. Thirdly, Mr Smith is in a lower tax band than his wife and as a result would pay less tax than the waiving shareholder.

A company may feel that rather than waiving dividends, an alternative approach would be to issue two share classes with different rights, one eligible to receive dividends and one not. However, this arrangement also risks being challenged by HMRC if the company’s retained profits were not enough to pay the dividend against all issued shares across the share classes.

 

Checklist

To make sure that your dividend waiver does not draw the attention of HMRC, check that:

  • The dividend waiver is being made for a real business benefit and record this as part of the Deed of Waiver.
  • The waived funds are retained by the company and not simply divided up between the other shareholders receiving the dividend.
  • The shareholder who is waiving the right to a dividend would be satisfied with the arrangement if the other shareholders were unrelated third parties – i.e. not people who the waiving shareholder would particularly like to benefit.

With Inform Direct, you can easily identify shareholders who have signed a waiver, including whether this is for all the shares that they hold or just a proportion of them.

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