Waving Goodbye to Dividends?

Dividend waivers are vulnerable to the Settlement rules

In a typical PSC, contractors rewarding themselves with dividends is a tax efficient method of extracting profits from their companies. Dividend waivers, i.e. where a shareholder foregoes their right to a particular dividend, can also improve that efficiency but contractors must be aware of the waivers that HMRC will challenge under the Settlements Legislation, aka S.660A.

HMRC always eye dividend waivers with suspicion but the legislation cannot be applied to genuine waivers. In order to make the legislation stick, HMRC must demonstrate that the person waiving the dividend has retained an interest in the income they have surrendered.  Where the person benefiting under the arrangement is not a spouse, civil partner or minor child (under the age of 18) the Settlements Legislation will generally not apply.

Indicators that will arouse the suspicions of HMRC are:

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

Example 1:

Mr and Mrs H owns 20 and 80 ordinary shares in H Ltd respectively. In 2010. The company made a profit of £25,000. Mrs H, the higher paying taxpayer, waived her right to any dividend. The company then declared a dividend of £1,000 per share and as a consequence, Mr H received a dividend of £20,000. Clearly a dividend of this amount could not have been paid from the company’s profits on all the shares (£1,000 per share x 100 shares = £100,000), so the waiver arrangement enhanced the dividend paid to Mr H. £16,000 (£20,000 x 80/100) of the dividend paid to Mr H is attributed to Mrs H and taxed on her.

Example 2:

Mrs T (a higher rate taxpayer) owns 80 ‘A’ shares and Mr T (a basic rate taxpayer) owns 20 ‘B’ shares in T Ltd. Both A and B shares rank equally. The company made a profit of £25,000 in 2010 and a dividend of £20,000 is voted on the B shares, while no dividend is voted on the A shares. Only by not voting dividends on the A shares could the dividend be paid on the B shares. As in example 1 above, £16,000 of the dividend paid to Mr T is attributed to Mrs T and taxed on her accordingly.