When a company pays a dividend, all shareholders holding the same class of shares must receive dividends in proportion to their shareholdings. To pay dividends at different rates, a company must either issue different classes of shares with distinct dividend rights or vary the proportions held by shareholders. Alphabet shares are commonly used to provide such flexibility.

What are alphabet shares?

Alphabet shares are different classes of shares identified by letters, such as ‘A’ ordinary shares and ‘B’ ordinary shares. They allow dividends to be paid to one class of shareholder without requiring equal dividends to all shareholders. This can be particularly useful where shareholders are taxed at different rates, e.g., where one shareholder is a higher-rate taxpayer and another is a basic-rate taxpayer or non-taxpayer.

In addition to differing dividend rights, alphabet shares may allow different voting rights or other restrictions, such as redeemable or non-redeemable rights. However, where shares are intended to qualify for the spouse exemption under the settlements legislation, care should be taken to ensure the shares carry full ordinary share rights and are not substantially restricted. Otherwise, HMRC may argue that the recipient has not acquired true ownership but only a right to receive income and tax dividends on the original shareholder instead. Therefore, shareholders should retain genuine beneficial ownership of their shares, including rights to capital, voting and future growth, rather than holding shares solely to receive dividends.

‘Settlements’ legislation

The settlements legislation is designed to prevent income being diverted from one person to another for tax advantages while the original owner retains effective control or benefit. Dividends paid on certain classes of shares must represent a genuine return on investment rather than effectively being remuneration for services taxed as employment income under PAYE and NIC.

HMRC’s stance

HMRC can now more easily identify who owns shares in which companies through enhanced digital reporting, data matching and Companies House transparency reforms.

In addition, as from 6 April 2025, any person who was a director of a close company during the relevant tax year must include the name and registered number of the close company, the dividend amount received by the taxpayer and the percentage of the share capital owned in their personal self-assessment tax return. The intention of this additional declaration is to enable HMRC to identify cases where a director’s dividend income appears inconsistent with their shareholding as declared to Companies House or where income-shifting arrangements may exist and merit further review.

Family investment companies (FIC)

Alternative structures such as a FIC may be worth considering. A FIC is a private company set up to hold, invest and distribute family wealth.

The typical structure involves parents as both directors and shareholders, retaining voting control through a single share class. Children or grandchildren are allocated different share classes with limited or no voting rights but entitlement to dividends and capital growth. Care must be taken where parents provide funds for the children’s share subscriptions or where the dividend policy is structured to benefit the children at the expense of the parents.

Suggested action

• Directors should be wary of creating alphabet shares immediately before declaring a dividend or after substantial reserves have accumulated, as HMRC may view this as evidence of income shifting.
• Generally, dividends should be paid into an account beneficially owned by the shareholder concerned. Genuine joint accounts are usually acceptable.
• If a future sale of the company is anticipated, shareholders should consider the qualifying conditions for Business Asset Disposal Relief. Any restrictions attached to alphabet shares may affect eligibility.

Practical point

Failure to maintain proper documentation can increase the likelihood of an HMRC challenge. Directors should ensure the articles of association permit the creation of alphabet shares, board minutes and shareholder agreements are in place, and all dividend declarations are properly documented and implemented in accordance with the company’s articles