Companies (particularly those business ventures which were originally founded as owner / manager enterprises,  and whose stakeholders are familiar with taking their “rewards from business” / “profit extractions” – in a mixture of salary and bonus employed remuneration and shareholder dividends) – sometimes seek to “expand” their own historic approach; and therefore decide to implement arrangements rewarding and/or (part-)remunerating certain of their (usually) “key-man” employees – using a relatively informal “dividend shares” arrangement (often – regrettably – that has not “properly” – if at all – been professionally advised upon).

The danger is particularly acute when business owners have taken their advice “over a drink in the ‘Nineteenth (19th) Hole’ from their mate that they have just played a round with” – Although incredibly, there are negligent professional advisors who advocate the introduction of “Alphabet Share Schemes”.

Such arrangements will generally involve “grants” (i.e. gifts) of dividend-bearing shares to their employees – believing that such an approach is “clever” and “tax-efficient” – particularly in its prima facie saving of employer and employee national insurance contributions (NICs).

There are (however) significant technical adverse taxation implications (that are potentially likely to arise).

Even if HMRC may not practically have the resources to actively “police” the collection of the relevant taxation due at the time – the relevant tax (and interest and penalties) can “attach themselves” as potential PAYE etc. liabilities upon the employing company.

This often means that should the owners come to consider a sale of the relevant employing company – then how the accrued unpaid tax liability is dealt with – is likely to become a problematic (and potentially costly) issue to be dealt with at the relevant time.

On a very simple basis of explanation, any shares which have an expectation of significant dividends being paid upon them (in the future) – must (logically) have a significant value – and – if the employer provides such shares to employees for no (or nominal) consideration – then the provision of the relevant valuable shares to an employee falls to be taxed as employment income under general taxation remuneration principles.

If a share is likely to receive a dividend of “100” per annum, then it wouldn’t be unreasonable to apply a price/earnings ratio reflecting a reasonably significant number of years of income – the result of which is then subject to income tax. 

Thus a perceived saving of NICs etc. on “100” – is transformed into an income tax charge on “Years x 100” = Quite painful!

Further, on an ongoing basis – there may well be an ability for HMRC to re-classify years of dividends as remuneration/income under anti-avoidance provisions – particularly if dividend-bearing shares are obviously / being blatantly used to replace salary or bonus – which can even lead to double taxation – with interested parties being subject to taxation upon both the dividend received and upon remuneration for employment basis!

That’s not to say that with careful, and skilled implementation – the risks of such arrangements can be significantly reduced – but companies should exercise considerable caution, and not believe that such arrangements can be freely implemented – without fully understanding the potential issues.

However, there are BETTER profit extraction arrangements – using alternative business structures which can quite legitimately save taxation upon profit extraction – while (in many cases) better “fitting” the operations of the relevant business.

Should anyone be considering implementing an “Alphabet Share arrangement” (as discussed above) – they should please contact us to discuss what can (and should) be achieved to avoid the potential pitfalls / discuss better alternatives.


Founding Principal – and – Business Law Solicitor

+44 (0) 20 8780 3319 : London D.D. Landline Tel. – Solicitors For Business

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