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Different Share Classes: Genuine Business Reasons?
Alphabet shares, so called due to being named after each letter of the alphabet in turn, ie A shares, B shares, etc. are used to describe different classes of shares in a company. The shares can have whichever rights have been specified in the company’s Articles of Association or Share Agreement, and usually each type has different rights to the rest. Companies use alphabet shares for a variety of reasons, some of which we’ll explore below.
Alphabet Ordinary Shares
Alphabet ordinary shares (‘A Ordinary shares’, ‘B Ordinary shares’, etc.) are used for a range of purposes, most often to allow a company to pay dividends at different rates per share to each shareholder. Family companies and joint ventures also use them to provide specific rights (like being able to appoint a director) to certain shareholders.
Dividend Rate Difference
As we know, dividends tend to be a more tax-efficient means of paying income to directors or shareholders than salaries. Companies like to be able to pay dividends that are not proportionate to the shareholdings of the individuals, so all of one share type, eg A ordinary, would be held by one person, with the next share type being held by another and so on. This enables the company to declare dividends of one rate to the A shares, and another rate for the other share types, providing they have a clause in the Articles of Association allowing the directors to vary the dividends in this way. The other voting rights (voting, rights to capital on winding up etc.) usually rank equally.
Employees and Alphabet Shares
Some companies give employees shares to enable them to be paid part of their remuneration with dividends. Quite a popular employee incentive, the schemes must be structured correctly, and will encourage employees to try to maximise the company’s profits and allow the employer to pay their employees in a tax-efficient way. Shares here tend to be non-voting and perhaps be redeemable at par value (maybe £1 on a £1 share) to allow them to be taken back if ceasing their employment. Different letters may be used in smaller companies for each employee, and this is to provide maximum flexibility per employee.
Be aware that any share movements of this nature may be fraught with tax difficulties. It’s easy to see how HMRC may flag employee alphabet shares as a way to evade paying National Insurance contributions, so ensure you take appropriate professional advice before any share movements! There are four ‘approved’ share schemes – two issuing shares and two giving options – that are tax advantageous and you can read our blog on those here.
Family Companies and Alphabet Shares
Private companies may issue shares to the directors’ spouses or partners, or children. Traditionally, this was used to enable income from the company to be distributed among the family by paying them dividends, and for longer term capital tax planning. Alphabet shares provide flexibility over the dividend payments so that different amounts can be paid to different family members as required. Those shares can be voting or non-voting, redeemable or non-redeemable, and have other rights or prohibitions as necessary.
Setting Up Alphabet Shares
HMRC may question the need for alphabet shares, as historically they were abused to save on high tax. ICAEW guidance is that providing that the alphabet shares are necessary for genuine commercial reasonings, then they’re fine, however splitting existing share types purely for personal reasons will stir up a hornets nest. If you can show that you’ve considered just splitting the ordinary shares and that it wasn’t appropriate for commercial reasons, that’s fine, but expect questions! HMRC will come down hard on you if they feel that your only reason for using the alphabet shares is to avoid paying tax, and you’ll end up being required to pay more tax in any case.
Once you’re satisfied that alphabet shares are the way to go, you must create the new share class and set them out in the Articles of Association and have those Articles adopted by a Special Resolution of the company. You can then allot or convert as necessary. Directors and shareholders must all approve the changes. We strongly recommend both legal and tax advice before making any changes of this nature.
Contact us if you have any questions, we’re more than happy to discuss them!
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