In an alphabet share structure, each shareholder has a different class of share. For example, one shareholder may have A ordinary shares, another B ordinary shares, another C ordinary shares, and so on. The benefit of an alphabet share structure is that it provides the flexibility to tailor dividends to take account of the shareholder’s personal circumstances. Under company law, dividends must be paid in proportion to shareholdings. Having an alphabet share structure overcomes this restriction and is popular in family companies.
Utilising The Dividend Allowance
One advantage of an alphabet share structure is that it allows dividends to be paid to a shareholder who may work outside the family company but who has not fully used their dividend allowance for the tax year. The available dividend allowances can be utilised to increase the profits that can be extracted tax-free.
However, the dividend allowance is being reduced, curtailing the opportunities to extract tax-free profits in this manner. The dividend allowance was set at £2,000 for 2022/23. It is reduced to £1,000 for 2023/24 and to £500 for 2024/25. Thus, in a family company with four shareholders, it was possible to extract £8,000 of profit tax-free by making use of the shareholders’ dividend allowance in 2022/23. By 2024/25, it will only be possible to extract £2,000 of profit tax-free in this way.
Using Lower Tax Bands
Although the reduction in the dividend allowance reduces the potential to extract profit free of further tax, having an alphabet share structure in place may still be beneficial if the shareholders have different marginal rates of tax, allowing dividends to be tailored so that they are taxed at the lowest possible rate. For 2023/24 dividends are taxed at 8.75% where they fall in the basic rate band, at 33.75% where they fall in the higher rate band and at 39.35% where they fall in the additional rate band.
Albert, Betty, and Charlotte are shareholders in ABC Ltd. Albert has 100 A ordinary shares, Betty has 100 B ordinary shares and Charlotte has 100 C ordinary shares.
For 2023/24 the company has profits of £45,000 that they wish to extract. Albert has another job and is an additional rate taxpayer. Betty has an income from property of £35,270 a year and Charlotte has an income of £20,270 from her part-time job. They all have their dividend allowance available.
To minimise the tax payable, the company declares a dividend of £10 per share for A ordinary shares, a dividend of £150 per share for B ordinary shares and a dividend of £290 per share for C ordinary shares.
Albert receives a dividend of £1,000. This is sheltered by his dividend allowance and is tax-free.
Betty receives a dividend of £15,000 of which £1,000 is sheltered by her dividend allowance and is tax-free. The remaining £14,000 is taxable at the dividend ordinary rate of 8.75% (a tax bill of £1,225), which uses up her remaining basic rate band.
Charlotte receives a dividend of £29,000 of which £1,000 is sheltered by her dividend allowance and received tax-free. The remaining £28,000 falls within her basic rate band and is taxed at 8.75% (a tax bill of £2,450).
The total tax bill is £3,675.
Had each taxpayer received a dividend of £15,000, the total tax bill would have been £7,959. Albert would pay tax on £14,000 of his dividend at 39.35% and Betty and Charlotte would each pay tax at 8.75% on £14,000 of their dividend. The remaining £1,000 of each dividend would be sheltered by the dividend allowance. By having an alphabet share structure, they can tailor the dividends to reduce the total tax bill by £4,284.
Partner Note: ITA 2007, ss. 8, 13 and 13A.