Here we look at the situation where a dividend payment has been declared but a shareholder would either prefer not to receive payment of all or part of the dividend or it would be tax advantageous overall for him not to do so. Consideration is given as to why this situation may arise and what can be done, if anything, such that the shareholder gets his wish.
Reasons Not To Withdraw A Dividend
As we have seen in chapter one, when a company pays a dividend, all shareholders having the same class of share receive payment in proportion to their individual shareholdings. It is effectively a case of ‘all or nothing’ - one shareholder cannot be paid in preference to another or be paid at a different rate unless the company has different types of shares or the underlying shareholdings are changed. Such inflexibility sometimes results in the distribution of profits not being made in the most tax-efficient manner or may produce difficulties for a shareholder who does not want or need the payment.
An example of tax inefficiency is where one of the shareholders is a ‘higher rate’ taxpayer and the others are either ‘basic rate’ taxpayers, or possibly do not pay tax. A shareholder may also prefer not to receive a dividend payment if he claims Child Tax Credit (CTC), as inclusion in the calculation may take his total income over the CTC limit, or if by taking the payment the shareholder is affected by the higher income charge on Child Benefit.
In such situations, dividend waivers may be invaluable - but only if used correctly and carefully.
Practicalities Of Dividend Waivers
Should a shareholder decide not to take the dividend, a formal ‘deed of waiver’ election is required, which must be signed, dated, witnessed and lodged with the company; without a deed HMRC could argue that the dividend stands. The ‘waiver’ election must state that the waiver is voluntary. Dividend waivers are only effective if executed by deed because there is no consideration to support a contract.
It is most important that the waiver is in place before the right to the dividend arises because a waiver afterwards could be construed as a ‘settlement’ transfer of income (this situation is considered in the next section ‘the Settlement Provisions and Dividend Waivers’). The waiver can refer to a single dividend or a series of dividends declared during a specified period. An interim dividend must be waived before being paid, and a final dividend waived before being approved. For detail, see section 1.5 ‘Payment Date’.
The other shareholders will still receive their proportion of distributable profits in the proportion of each of their respective holdings, whilst the shareholder who has waived his dividend will receive nothing - his share of the profit remaining in the company’s bank account.
Dividend waivers lasting more than a year are rare because a longer-term waiver could reduce the value of that shareholding. In turn, that could increase the value of those shareholdings the holders of which could then receive higher dividends possibly resulting in a higher tax liability.
ABC Ltd has distributable profits of £40,000. The directors of the company are three brothers and they wish to pay a total dividend of £30,000 as follows:
The number of shares held by each brother is as follows:
Alan 50 shares
Ben 25 shares
Colin 25 shares
Alan wishes to waive his dividend and thus receive no payment. Therefore, Ben and Colin will receive £7,500 each (i.e. £30,000 x 25/100). Alan’s waived dividend will remain within the company’s bank account.
The ‘Settlement’ Provisions And Dividend Waivers
As stated in section 3.2, the amount of dividend waived remains within the company. However, this also means that there are additional funds available for the remaining shareholders. The question is - is there anything to stop the directors from increasing the dividend for the remaining shareholders should additional funds be available following a dividend waiver? The answer will depend upon the reason for the waiver. HMRC may argue that the waiver has indirectly provided funds for an ‘arrangement’ or ‘settlement’ to apply; an element of ‘bounty’ being required for the ‘settlement’ provisions.
Practicalities of the ‘Settlement’ legislation
This tax legislation is to be found in chapter 5, Part 5 of Income Tax (Trading and Other Income) Act 2005. This section has been used by HMRC on many occasions to try and counter director shareholders in particular from diverting their income to family members who pay tax at a lower marginal rate than the shareholder himself. The ‘settlement’ rules are anti-avoidance provisions and apply where the settlor (i.e. the person gifting an asset) retains an interest in the asset given away and the settlor or the settlor’s spouse benefits from the gifted asset. There are some exceptions to the ‘settlement’ rules, including an important one for gifts between spouses or civil partners (see tax case of Buck v HMRC  detailed below).
In practice, HMRC is only likely to take the above ‘settlement’ where the waiver is considered to create a tax advantage, an element of ‘bounty’ being needed for the ‘settlement’ provisions to apply.
Using the same details as in Example 1, Alan waives his entitlement to a dividend and the Directors agree to grant Ben and Colin an increased amount of £15,000 each (i.e. £600 per share).
HMRC may challenge this waiver contending that by making the waiver Alan has ‘settled’ £7,500 on each of his brothers. Even though Alan has not received any money himself, HMRC may try to tax him on the amount of dividend waived on the grounds that an element of ‘bounty’ has passed from one shareholder to another.
The basis of HMRC’s contention may be that although the total amount of dividend paid of £30,000 is less than the amount of distributable profit (£40,000), if Alan had not waived his dividend then the company would not have had enough distributable profits available to pay the increased amount of £600 per share (£600 x 100 = £60,000), hence an element of ‘bounty’ must be present.
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This article was first printed in Business Tax Insider in September 2019.