Dividends are considered to be the most tax-efficient form of income. That’s why they are often chosen by directors of companies and taken as their income. However, depending on different company structures, there can be reasons why some directors are paid more dividends than others.
The same applies to shares. Holding different values and types of shares plays an important role in the growth of a business.
Both these critical aspects can be controlled through ‘alphabet shares’.
Alphabet shares can indeed have tax implications and liabilities. While HMRC may not approve of these shares, it is important to consult with a tax professional before proceeding. The potential for tax savings through alphabet shares depends on various factors, including the specific structure and purpose of the organization.
It is vital to ensure compliance with tax laws and regulations to avoid any potential penalties or legal issues. Seeking professional advice is crucial in understanding the tax implications and potential benefits of using alphabet shares.
This blog tells you everything that you need to know about these shares, how they help in alphabet share tax planning, and their pros and cons.
What Are Alphabet Shares?
Let’s start with the basics and understand what alphabet shares are.
These shares are defined as the ones that allow a company to distribute different classes of rights to their shareholders. Alphabet shares are classified by alphabet such as ‘A’, ‘B’, ‘C’, and so on.
To create this new class of shares, a provision must be made in the Articles of Association of the company. Since the Companies Act 2006 provides that dividends must be paid in accordance with the proportion of shares held by an individual, any amendments in the provisions of these shares must be adopted by passing a special resolution.
These resolutions and statutory forms must be sent to the Companies House for their records.
Your company can either create new shares or convert existing shares into alphabet shares after approval, first, by the directors, and then the company’s shareholders.
Why Are Alphabet Shares Issued?
Alphabet shares are mostly issued by small family-owned companies, joint ventures, or other companies when different rights need to be attached to different classes of shares.
Some of the most common reasons to issue alphabet shares include:
Paying Differential Rates of Dividends
When your company issues ordinary shares, you need to pay dividends to all the shareholders in proportion to shares held by them. One of the main reasons for issuing alphabet shares is that you have the flexibility of paying dividends in the ratio that you see fit.
This means that holders of ‘A’ category shares will get dividends at a different rate than shareholders holding ‘B’ category shares.
Joint Venture Companies
Another instance where alphabet shares are very helpful is when the company is a joint venture. These shares are used to define the rights and representations of each of the joint owners in the joint venture.
For instance, say there are three companies in a joint venture and they are offered shares ‘A’, ‘B’, and ‘C’ respectively. The joint venture’s articles of association may provide that ‘A’ shares of company A may allow for certain directors to be removed.
A normal scenario in family-owned companies is that some family members are more involved in the running of the company than others. And in such a scenario, they naturally expect more shares and rights on the family income.
Issuing alphabet shares in a family-owned company allows this flexibility to pay out the dividends and the company income to be apportioned accordingly. These shares can also be used to offer additional rights to the family members such as making key decisions or voting rights.
Another use case of alphabet shares is that they are issued to employees to motivate them to work harder towards maximising profits. Another reason why these shares are issued to the employees is to keep them loyal towards the company in the longer run.
Employees can enjoy tax benefits as they receive their salary as dividend payments. They are issued to demarcate between different cadres of employees. Usually, the alphabet shares issued to employees are non-voting shares and can be redeemed at par value once the employee resigns from the company.
How to set up alphabet shares
To establish a new class of share, the process involves incorporating the relevant provisions in the company’s Articles of Association. Any changes to this class of share require a special resolution. Once established, the new class can be allocated to individuals or existing shares can be converted to the new class.
In order for any changes to be implemented, approval is required from both directors and shareholders.
Under the updated procedures of the Companies Act 2006, it is necessary to send all relevant resolutions and statutory forms to Companies House. The default Articles of Association, known as the Model Articles or Table A, state that dividends should be paid based on the number of shares held by a shareholder. To accommodate the use of alphabet shares and the payment of varying dividend rates, it is crucial to amend these Articles accordingly.
What Are The Pros and Cons of Issuing Alphabet Shares?
Now that you know the use cases of issuing alphabet shares, let’s take a look at their pros and cons.
Pros of issuing alphabet shares
Equal treatment of shareholders
One of the most important advantages of issuing alphabet shares structure is that they allow the shareholders to be treated fairly. In any company, the participation of every shareholder in daily operations varies.
Alphabet shares are a great way to reward such shareholders and motivate them to help the company grow.
Cost saving through tax efficiency
Another important advantage of issuing alphabet shares is that they are a vehicle for paying shareholders through dividends instead of salaries. This saves the company a lot of money in taxes, which can be ploughed back in for use in more productive activities.
Control over the future growth of the company
Alphabet shares allow for several rights to be distributed amongst the most-involved shareholders. This ensures that people who are in the know-how of the company’s operations are allowed to be in charge of the key decisions that affect its growth and profitability in the long run.
Cons of issuing alphabet shares
Practically, alphabet shares have zero cons provided they are issued in accordance with the statutory guidelines of HMRC. They should also have been provisioned for the right reasons instead of being utilised for the purpose of tax evasion.
It is advised that alphabet shares should not be provisioned immediately before the year’s dividend is due or when the company has a large income transfer due. This could be viewed by HMRC in a bad light.
What is the difference between ordinary shares and alphabet shares?
Ordinary shares, also known as standard shares, are typically issued by companies and give shareholders certain rights. Each ordinary shareholder is entitled to one vote per share and receives dividends in proportion to the number of shares they hold.
On the other hand, Alphabet shares offer flexibility in terms of dividend rates for specific shareholders. Additionally, the rights associated with each share class can be customized or limited as needed.
Alphabet shares do much more than help in tax saving and planning. They ensure equitable distribution of shares and in turn the company’s growth by recognising and motivating shareholders who perform. To avoid making any errors in issuing these shares and attracting penalties from HMRC, it is advised to get advice from professionals. Get in touch with us to know how we can help you issue new shares and protect the interests of all the stakeholders.