Alphabet Shares: A Practical Guide for UK Company Owners

If you run a UK limited company, you have probably heard other business owners talk about alphabet shares as a way to pay different dividends to different people. When used well, alphabet shares can be a powerful planning tool. However, when used badly, they can create tax risk, shareholder disputes and a lot of unwanted attention from HMRC.

In this guide, we will walk you through what alphabet shares are, when they are commonly used, their benefits and downsides, and how they interact with dividends, tax and dividend waivers. We will also highlight why this is fundamentally a corporate legal matter, and how Agile Accountants in Birmingham city centre can work alongside specialist corporate solicitors to ensure your structure is right for you.

What are alphabet shares?

In simple terms, alphabet shares are different classes of ordinary shares, usually labelled A, B, C and so on. Each class carries its own rights, which are set out in the company’s Articles of Association.

Under the Companies Act 2006, companies are allowed to issue different share classes as long as the rights are clearly defined in the Articles. Shares are treated as being of the same class only if the rights attached to them are uniform in all respects.

With a typical alphabet share structure:

• Shareholder 1 might hold A Ordinary shares
• Shareholder 2 might hold B Ordinary shares
• Shareholder 3 might hold C Ordinary shares

Each class might have different:

• Dividend rights
• Voting rights
• Rights on a sale or winding up
• Transfer restrictions

A key feature is that the company can declare dividends on one class and not another, or at different rates between classes, as long as company law rules are followed and there are sufficient distributable reserves.

When do companies use alphabet shares?

Alphabet shares are most commonly seen in:

1. Fast growth start ups

• To separate rights between founding shareholders and new investors.
• To create classes linked to growth or exit value.

1. Companies with a small senior team

• To reward key managers with dividend rights that reflect performance or contribution, without issuing standard employee options.

1. Situations where passive shareholders are involved

• For example, one shareholder works full time in the business, another is largely passive. Alphabet shares may allow higher dividends to the working shareholder, subject to tax rules.

In every case, the commercial rationale should come first. Tax planning is often part of the conversation but should not be the only factor.

Benefits of alphabet shares for UK limited companies

When properly designed and documented, alphabet shares can offer several advantages.

Dividend flexibility with alphabet shares

The standout benefit is dividend flexibility. Without alphabet shares, company law requires that dividends are paid to all shares of the same class in proportion to their holdings. With a single class of ordinary shares, you cannot legally pay different dividends to different shareholders within that class.

Alphabet shares allow you to:

• Pay dividends on A shares and not on B shares, or vice versa
• Pay different rates of dividend on different classes, while keeping the underlying ownership percentage unchanged
• Defer or reduce dividends for one shareholder in a particular year

This can help when:

• One shareholder wants to extract more income from the company while another prefers to retain profits
• You want to reward active directors differently from passive investors

Specialist guides describe this dividend flexibility as one of the main reasons alphabet shares are used in practice.

Supporting succession, spouses and key team members

Alphabet shares can also help with:

• Succession planning

Gradually bringing adult children or next generation shareholders into the ownership structure, with dividends that reflect their stage of involvement.

• Spouses and civil partners

Allowing each to hold a separate class of share, to support income planning within the family, subject to the settlements rules.

• Key employees

Creating a class of shares with limited rights but the ability to receive dividends once performance targets are met.

Risks and pitfalls of alphabet shares

Alphabet shares are not a quick fix. Poorly structured arrangements can create serious tax and legal problems.

HMRC settlements legislation and income shifting

HMRC is particularly interested in situations where alphabet shares are used to divert income from a higher rate taxpayer to a lower rate taxpayer, for example between spouses.

The settlements legislation in Part 5, Chapter 5 of ITTOIA 2005 can apply where a person arranges for income to go to someone else but effectively keeps the benefit. HMRC and several professional bodies have debated how this applies to alphabet shares, and HMRC examples show that some share arrangements can be challenged as a settlement.

Key risk areas include:

• Creating new share classes where the main aim appears to be moving dividends from one spouse to another on a lower tax rate
• Arrangements where control of the company and the flow of dividends remain effectively with one person, despite shares being held in different names

If the settlements rules apply, HMRC can tax the dividend back on the person who set up the arrangement, removing the perceived tax benefit.

Employment related securities and staff share classes

A second pitfall is where alphabet shares are used to pay what are essentially wages in the form of dividends to employees.

HMRC’s Employment Related Securities Manual gives examples of companies creating multiple special share classes so that employees can receive most of their remuneration as dividends rather than salary. These arrangements can fall under employment related securities anti avoidance rules, with potentially severe tax consequences.

If you are considering alphabet shares for staff, it is crucial to:

• Understand the interaction with PAYE, National Insurance and employment related securities rules
• Ensure the structure has a genuine commercial purpose beyond simply saving tax

Tax implications of alphabet shares

From a company law perspective, alphabet shares are perfectly legitimate, provided the Articles and shareholder approvals are dealt with correctly. Tax is where things become more nuanced.

Some key points:

• Dividends remain investment income
  For UK resident individual shareholders, dividends on alphabet shares are usually taxed as dividend income at the shareholder’s marginal dividend tax rate. Alphabet shares do not magically turn dividends into something else.
• No guarantee of overall tax savings
  Any tax advantage depends on the shareholders’ wider circumstances, other income and how HMRC views the arrangement. In some cases there may be no saving at all.
• Anti avoidance rules
  The settlements legislation, the Transfer of Assets rules and employment related securities rules can all potentially apply, depending on how alphabet shares are used.
• Business Asset Disposal Relief and CGT
  The way share classes are structured can also affect eligibility for Business Asset Disposal Relief on a future sale, because the legislation looks at share capital and voting rights in the personal company. Poorly designed alphabet share structures can accidentally dilute an individual’s qualifying interest.

Because of this, alphabet shares should always be seen as one tool in a broader planning conversation, not a stand-alone tax trick.

Dividend waivers and alphabet shares

Alphabet shares are sometimes mentioned in the same breath as dividend waivers, but they are different concepts.

• An alphabet share structure changes the rights attached to shares permanently or until varied again.
• A dividend waiver is a one off decision by a shareholder to give up their right to receive a particular dividend.

HMRC is cautious about dividend waivers, especially where they appear to shift income between spouses or family members. HMRC guidance notes that waivers can fall within the settlements rules where the waiving shareholder still benefits indirectly from the income.

Specialist legal commentary also highlights that HMRC can and will challenge poorly implemented waiver arrangements, so formal legal documentation, correct timing and board minutes are essential.

If you are already using alphabet shares, dividend waivers should be approached with even more care. The tax analysis becomes more complex and the risk of HMRC alleging income shifting can increase.

Getting the legal structure right

This is the part many businesses underestimate.

Creating alphabet shares usually involves:

• Amending the Articles of Association to define each class and its rights
• Passing the right board and shareholder resolutions
• Potentially reclassifying existing shares into new classes, which is a formal Companies Act process, not just a bookkeeping changes
• Filing appropriate forms at Companies House and updating statutory registers

The structure needs to stand up not only to HMRC scrutiny but also to:

• Future investors carrying out due diligence
• Banks and lenders reviewing share capital
• A potential buyer of the company
• Disagreements between shareholders

Because of that, alphabet shares are very much a corporate legal matter as well as a tax and commercial discussion. Your accountant and your corporate solicitor should be working together, not in isolation.

At Agile Accountants we can coordinate with specialist corporate lawyers to ensure that:

• The share rights are drafted clearly and work in practice
• The Articles and resolutions match the planned structure
• Tax and commercial considerations have both been thought through before changes are implemented

How Agile Accountants can help

Alphabet shares can be a smart way to structure ownership, dividends and control in UK limited companies, but only when they are part of a joined up plan that covers tax, commercial and legal considerations.

As a Birmingham city centre firm working with owner managed businesses and fast growth start ups across the UK, Agile Accountants cannot create or amend your legal share structure for you. What we can do is:

• Help you decide whether alphabet shares are appropriate for your circumstances at all
• Model different dividend outcomes for each shareholder so you can see the numbers clearly
• Explain the tax implications and key HMRC risk areas in plain English
• Check that your bookkeeping, reserves and existing board minutes support valid dividend payments from an accounting perspective
• Introduce you to a specialist corporate solicitor who can draft or amend your Articles, share rights and legal documents, and work alongside them so that the financial and tax planning is properly reflected in the legal paperwork

If you are considering alphabet shares, or you already have an alphabet structure and want a second opinion, we would strongly recommend getting tailored advice from both an accountant and a corporate solicitor before making any changes or paying further dividends. Agile Accountants can coordinate that process and make sure everyone is working from the same set of facts.

If you would like to explore whether alphabet shares are right for your company, get in touch with the team at Agile Accountants to arrange an initial conversation and, where appropriate, a referral to a trusted corporate solicitor.