Whether to Waiver

The legal and tax implications of dividend waivers

Waiving an entitlement to a dividend can be fraught with tax dangers but they are nevertheless legal and it doesn’t always follow that they will be caught by the Settlements Legislation.

As a general rule dividends are only legal when declared from retained profits. Where dividends are paid but there are insufficient profits to do so, then the income will be treated as a loan or salary and taxed accordingly. Furthermore, if a company defaults on its debts, unpaid creditors can demand that the dividend be returned by the shareholders to enable their bills to be paid.

A company’s ability to pay dividends is determined by its own rules laid out in its Articles.

Under company law waiving your rights to dividends is legal but there are a number of important considerations to observe:

• document the waiver before the dividend is declared. A formal deed of waiver is required, which must be signed, dated, witnessed and presented to the company;
• the waiver must be commercially driven, e.g. retaining profits within the company for future investment;
• nothing should be given in consideration of the waiver;
• avoid regular dividend waivers as they are an invitation to HMRC to investigate; and
• waivers motivated by providing a tax advantage for a spouse will be challenged by HMRC.

For a dividend waiver to be caught by the Settlements Legislation there must exist an element of ‘bounty’, whereby one of the shareholders receives a larger dividend than would have been possible had not the waiver taken place.

Indicators that the Settlements Legislation may apply are set out in HMRC’s Trusts, Settlements and Estates manual:

• 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.

Where the cash is needed by the company for future business purposes then dividend waivers are a perfectly legitimate means of providing those funds but if they are simply used to reduce personal tax liabilities then be prepared for the tax inspector to come calling.