What is an Alphabet Share?

“Alphabet shares” is a term used broadly to describe unique classes of shares – for example, ‘A-shares, ‘B’ shares, and so on. These shares have certain rights allocated to them according to the company’s Articles or Terms of Issue. Therefore, alphabet shares are used for unique purposes in different companies. Examples include alphabet shares for family companies, those for new ventures, and those for employees.

When a company pays out a dividend, all the respective shareholders receive payment in accordance with their individual shareholdings. If the company wants to pay one shareholder in preference to another or pay them at a different rate, then they must either have different kinds of shares in place or the underlying shareholdings must be changed – or they must resort to dividend waivers – which we’ll explain in just a moment.

The way alphabet shares work is this:

Since dividends are at times a more tax-efficient way of paying income to shareholders and directors than salaries, most companies want to enjoy the flexibility of paying dividends that are not proportionate to the individual’s shareholdings. And, in such cases, the ‘A’ ordinary shares are held by one individual, all the ‘B’ ordinary ones by another, and so it goes.

A dividend can then be declared on the A ordinary shares at a fixed rate while on the B ordinary shares, there will be a different rate. In order for the company to pay different rates on, for example, the ‘A’ and ‘B’ ordinary shares, it must explicitly have a clause in the Articles which allows the shareholders to vary the dividends between each class or ‘alphabet’ of shares. The concept may be a bit confusing to grasp at first, but it isn’t, once you know how alphabet shares generally work.

What is a Dividend Waiver?

Shareholders in a company have the option to receive income as dividends, which the company must declare after retaining profits. A dividend waiver simply refers to a shareholder ‘waiving off’ their entitlement to receive a share of the profits for the financial year. The waiver itself is a legally binding document prepared by a legal professional.

A common motivation for shareholders to waive off their dividend is when they feel they don’t require the money and that it would be better for the company to retain this as profit. Another reason is concerns around tax inefficiency because there are certain pitfalls associated with dividend waivers – no wonder the HMRC would rather have shareholders exercise their entitlement than waive it.

A dividend may only be waived off by a shareholder and not the company. However, if the company wishes to decide which shareholder should get a dividend, then it will need to come up with different classes of shares and also ensure that each shareholder has access to a unique class of shares (A, B, C, and so on), and never the same; this is where alphabet shares come in.

Dividend Waiver or Alphabet Waivers – Which one should I choose?

We discussed at the start of the article that whenever a company pays out dividends to its shareholders, the payments they receive need to be in proportion to each individual’s shareholdings. However, if they decide to pay different shareholders at different rates, then they’re either needs to be a dividend waiver in place or different types/classes of shares that allow for different rates to be given as dividends to different shareholders.

So, this begs the question: dividend waiver or alphabet shares? Let’s consider the following:

  • If a dividend waiver is currently the usual method for allowing surplus profit to be distributed as dividends to shareholders, but at a different rate for each shareholder, then alphabet shares offer a permanent solution.
  • A dividend waiver will likely attract attention from HMRC, particularly if the company does not have sufficient distributable reserves to pay shareholders the full dividend without any waiver in place.
  • Dividend waivers can be somewhat unreliable because the shareholders must provide their consent every time; however, dividends paid to alphabet shareholders do not require any consent from the other shareholders.
  • Alphabet shares offer different voting rights as well as other rights/restrictions – for instance, redeemable/non-redeemable rights to be assigned to the various classes of shareholders, as and when needed.
  • Alphabet shares offer flexibility in terms of dividend payment rate which means a payment may be made to a specific share class without the need to pay the same rate to every other shareholder. Companies find this particularly beneficial if one or more of the shareholders are in a higher tax bracket, while the others are basic rate taxpayers or non-filers.

Alphabet Shares and Dividend Waivers: Additional considerations to keep in mind

  • Any new shares created under the alphabet share scheme are considered a ‘gift’ and carry the same rights as the original ordinary shares. So, there can be no restrictions on these shares, for instance, “non-voting” or having lesser rights to capital or getting the shareholders to promise that the shares will be returned on demand. Therefore, the new shares cannot be made ‘redeemable preference shares.’
  • It’s probably best not to create any alphabet shares right before a dividend is to be paid out or as soon as your company has posted large income reserves – because in this case, income transfer may be seen as being the sole reason for creating alphabet shares.
  • If any shares are being gifted to spouses, it should ideally be shown that the spouse has vested interests in the functioning of the company – ideally, becoming Director at some point or, at the minimum, by assuming a formal role such as Administrator or Secretary. HMRC closely scrutinizes companies to ascertain where dividends are paid. A joint account would do just fine but all the while the account title must have the receiving spouse’s name.
  • In order to cut down the risk as much as possible of HMRC making a claim that the dividends may not be paid unless at least one class of share was not allocated to any dividend, it is best that companies pay at least some dividend to every class of share.

When deciding on whether to use alphabet shares or dividend waivers, it is always best to consult a solicitor before allocating shares or paying dividends, especially when it comes to staying off HMRC’s radar and ensuring that your shareholders are given the right class of shares or dividends.