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If you run a limited company, you are probably already aware of what shares are. Every time you pay a dividend, each shareholder will receive a payment equal to the value of their shares and the number they hold. While larger companies may not pay dividends as often, many SMEs use them as a way of paying directors and employees. But in order to do that, they need to be able to differentiate between different types of shares, so that they can pay each person the right amount. How do they do that? With alphabet shares.
What are alphabet shares?
All limited companies are required to create and distribute shares as part of their incorporation. They can choose whether they create 1 share or 1,000 shares, but each one represents a piece of the company, and the person who owns the share owns that much of the company. Think of it like cutting a cake. If the cake is cut into 2 and you have 1 piece, then you have half of the cake, and own half of the company. If it’s cut into 4 pieces and you have 1, then you have a quarter of the cake, and own a quarter of the company.
Alphabet shares exist as the simplest way of differentiating the different types of shares in your business. Some shares may have full ownership and voting rights, usually named class A shares. Other shares may have voting rights but no ownership rights and might be named class B shares. And you may then want to have a class of share that doesn’t have any rights, and just entitles the holder to dividend payments, and call these class C shares. The business can choose what rights each type of share has, and you will simply call them A, B and C shares. On top of things like voting and ownership rights, each share class can have a different value attached, so when you pay a dividend, each share class gets a different amount. Some share classes might be paid regularly, while others might be used for one off or irregular payments.
Ultimately, ABC shares are there to give businesses flexibility to pay dividends in the way they see fit for each individual shareholder.
How do alphabet shares work?
We know it can be difficult to visualise how this would all work in a real business, so here is a typical example:
Construction company X is owned by Callum and Lia, a husband-and-wife duo. Each of them holds 1 ordinary A share in the business, making them 50/50 partners. They want to take out £100,000 from the business to pay for an extension on their own home. With the dividends structured as they are, they would each need to take a dividend of £50,000 and pay the relevant personal income tax on it.
But what if Callum held 1 ordinary A share, but Lia only held an ordinary B share? This would allow the company to pay different amounts to each person. So, Callum might be paid £40,000, and Lia £60,000. This would help keep their overall dividend amounts below personal allowances and could help them manage their personal tax more efficiently.
Callum and Lia could have set up the company with A and B shares for a few different reasons. For example, Callum may have started the business a few years ago, and brought on Lia recently to help with the admin side of things as the business grew. B shares means Lia could be paid properly and flexibly, but not give her voting rights on the future of the company – which are only automatic for A shares.
The pros and cons of alphabet shares
Just like every decision you make in business, there are some pros and cons to using alphabet shares. The big advantage is that they give you the flexibility to choose who you pay what and when, regardless of the position. This can be incredibly useful particularly for smaller businesses, or for larger businesses who want to maximise their personal tax brackets. For small businesses they can also be good for paying employees, with a minimal salary and the remainder paid in dividends. In this case, each share would be redeemable at par value (£1 on a £1 share), and will usually have no voting rights, with a clause stating the shares must be returned to the company when the employee leaves.
And of course, there can be some negatives. Particularly in the way companies set up these shares, and for what purpose. HMRC is very keen that companies do not use ABC shares to avoid things like NIC or tax, and plenty of companies have been caught in the past. For example, a company was taken to court by HMRC because they set up new shares to pay bonuses as dividends rather than as employment income, meaning the recipients and the business would not have to pay as much tax on it. HMRC ended up winning that case, and the company were told to pay NIC on all dividend bonus payments. So, if you are looking to use ABC shares, we always recommend you speak to an accountant and make sure you are being above board at all times.
How do you set up alphabet shares?
When it comes to setting up ABC shares, the process is pretty much the same as normal shares. The process would normally look something like this:
- Create a new class of shares for each of your chosen share type
- Set the new classes of shares out in your company’s Articles of Association (a document that specifies the regulations for a company’s operations and defines the company’s purpose)
- Ensure the new articles detailing the new share classes are adopted by special resolution (written is preferred)
- Decide to either allot new shares of the classes concerned, or have existing shares converted to the new classes
- Both directors and shareholders consider and approve the changes to the company articles
- Send notices of the statutory forms and resolutions to Companies House
At Purple Lime, we pride ourselves in helping our customers structure their business in a way that works for them. Our bespoke approach means that we can help you figure out the most tax efficient way to pay yourselves and employees, and help you manage the whole process from start to finish. If you would like to know more, please get in touch by emailing email@example.com or calling us on 01249 691360.
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