We’re often asked about dividends and whether they can be waived. This article explains how to deal with these and how to avoid the “gotchas”.
What’s a dividend?
A dividend is a distribution of a company’s profits. As dividends are taxed at lower rate, typically a small business will arrange its remuneration to owners by way of a small salary and a greater dividend.
Dividends are typically paid in accordance with the shareholding. So, if you have 50% of the shares, then you receive 50% of the dividend.
Problems can arise however, when it is agreed (or not, as the case may be) that they level of effort by a particular owner is not commensurate with the dividend being paid. This is when the shareholder may look to vary, or even waive altogether, their right to a dividend.
What’s a dividend waiver?
When a shareholder does not want to be paid a dividend, he or she can have the right to this dividend waived. The reason this is likely to happen is where the waiving shareholder doesn’t need the money or feels that the funds would be better with the company.
For a waiver to be valid, and therefore unlikely to be challenged, there are a couple of requirements:
- The company reserves must be sufficient to pay the full voted dividend before the waiver was executed. In other words, if the company’s profits were £10,000 and 50% of the shareholders were waiving their dividend, only £5,000 may be issued in dividend.
- Formal paperwork must be drawn up, called a Deed of Waiver, and signed by the shareholder waiving their dividend.
- The Deed of Waiver must not be done retrospectively.
- A dividend waiver must be used for commercial reasons and not for tax mitigation purposes.
Any major gotchas?
Yes. As always, where HMRC are involved, there always is. When deciding whether a waiver constitutes a “settlement” and therefore should be taxed on the “settlor”, HMRC will look at the following criteria:
- Was the waiver tax motivated or was there a genuine commercial reason?
- Is there a history of regularly using dividend waivers?
- Were there sufficient profits in the year to cover the waived dividend?
- Was tax mitigated by using dividend waivers?
Conclusion and alternatives
While we agree that Dividend Waivers can be valid, we do believe that they should only be used sparingly, and only in the correct circumstances.
A more robust option would be to vary the shareholding in the company so that each shareholder hold a different class of shares and each of the share classes can have varying rights. For example, when things are equitable and the dividends are to be paid equally, then Class A shares and Class B shares get voted the same dividend, but when things require a little flexibility, then a different dividend can be voted for each class of share.