Owners of family-run and personal companies often adopt a compensation structure that involves a minimal salary combined with additional profits distributed in the form of dividends. The alphabet share structure (where each shareholder possesses a unique class of shares, such as A ordinary shares, B ordinary shares, etc.) provides an avenue for customizing dividend distributions to align with the individual circumstances of each shareholder.

Minor children are entitled to their own personal allowance (pegged at £12,570 for the 2023/24 fiscal year) and a dividend allowance (set at £1,000 for 2023/24). At first glance, disbursing dividends to minor children appears to be a strategic move to leverage their unused allowances. However, this strategy comes with a significant caveat. If shares are transferred from a parent to a child, and the dividends that result from those shares exceed £100 annually, those dividends are taxed as if they were the parent’s income, not the child’s.

Recently, HMRC has turned its attention to a specific dividend diversion strategy, which is being promoted as a tax planning tool for covering educational expenses. HMRC has expressed its stance that this approach is flawed and does not stand up to scrutiny.

Outline of the Dividend Diversion Scheme:

The company introduces a new class of shares, generally assigning specific dividend and voting rights to these shares.

An individual outside of the immediate family circle, such as a grandparent or an uncle/aunt, purchases these new shares at a value significantly lower than their market worth.

This individual then either transfers the shares to a trust or establishes a trust with the shares, designating the company owner’s children as beneficiaries.

The person who purchased the shares or the company owner then endorses a substantial dividend payment specific to this new class of shares.

The dividend payment is directed to the trust’s trustees.

As beneficiaries, the children of the company owner gain entitlement to the dividend.

HMRC asserts that such arrangements fall under the settlements legislation, rendering them ineffective for tax purposes. The crux of the issue is that the income is essentially being redirected from the company owner to their minor children, which means it should be taxed as the parent’s income, not the child’s.

It is crucial for individuals considering similar arrangements to be aware that they may also be subject to scrutiny under the settlements legislation, emphasizing the importance of seeking professional tax advice before proceeding.

 

 
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