Alphabet shares provide an alternative to dividend waivers, which can carry significant risks due to their lack of commercial substance.

Dividend waivers involve shareholders formally waiving their entitlement to declared dividends, enabling remaining shareholders to receive distributions to the exclusion of the shareholders who waived their rights. The form of a waiver needs to satisfy certain legal requirements and must pre-date the declaration of the dividend and remain effective for periods of less than twelve months.

On the other hand, alphabet shares create flexibility in the structure of dividend payments. Each share class carries defined rights regarding dividend participation, enabling differential dividend policies to be implemented through board resolutions declaring different rates for different classes.

Alphabet shares, therefore, enable long-term dividend planning strategies that increase flexibility both for existing requirements and in the event of future changes to shareholder and business requirements.

Having said that, there is a danger where income is diverted solely for tax purposes, particularly where shares are acquired undervalued by family members or where dividend policies are structured to benefit specific shareholders based on their tax positions rather than commercial considerations.

The fundamental principle underlying successful alphabet share arrangements involves being able to demonstrate a genuine commercial rationale extending beyond tax efficiency considerations. This requires evidence that different share classes reflect meaningful economic distinctions between shareholders based on their varying contributions to business success, different risk appetites, distinct liquidity requirements, or different levels of business involvement.

Issues can arise where non-working family members acquire valuable shares without providing adequate consideration or where dividend policies systematically favour shareholders with lower tax rates despite their limited contribution to business success.

If dividend planning is to be conducted successfully between spouses, the use of dividend-only shares significantly increases the risk of a challenge from HMRC. The class of shares held by the lower-income spouse must carry genuine capital and/or voting rights.

When issuing alphabet shares, you should avoid the following:

• Founders gifting shares or selling them at an undervalued price to family members
• Founders providing funds for the junior generation to subscribe for shares.
• Altering share rights with the expectation of an advantage to other shareholders
• Founders providing services without adequate remuneration, with the expectation of benefiting family shareholders
• Intentions to pay dividends disproportionately on shares held by family members.

HMRC will also look at the following:

• Whether sufficient distributable reserves exist for equal dividend payments
• Whether systematic patterns of differential dividends emerge over multiple years
• The relationship between dividend recipients and non-recipients
• Whether tax advantages are obtained through the arrangements
• The commercial rationale for differential treatment
• A arrangements involving shares with restricted rights subscribed at par,
• dividends paid on share classes held by minor children.

There are specific provisions to prevent income diversion to minor children, making alphabet shares inappropriate for under-18 beneficiaries in most family company situations, regardless of commercial justification and creates absolute barriers to using alphabet shares for succession planning involving minor children.

Alphabet shares continue to represent valuable tools for achieving tax-efficient profit extraction within owner-managed business structures, particularly where different shareholders have varying degrees of business involvement, different income requirements, and different tax circumstances. But Alphabet’s share structures and dividend policies should demonstrate genuine commercial substance extending well beyond simple tax efficiency considerations.