Limited companies make dividend payments to their shareholders from any profits left over after tax. The dividends that you pay out to shareholders don’t have to be for an equal amount, but your shareholders will need to have different classes of shares for this to happen. In this article we explain how dividends can be paid out for unequal amounts.
Shares are used to show ownership of a limited company – literally a share of the business. Some shareholders might own more shares than others, which means that they own different percentages of the business.
The percentage of shares owned is used to calculate the amount of dividends that a shareholder receives. Someone who owns 30% of a business’ shares will usually receive 30% of the profits, for example. Working on this basis can help to ensure that shareholders get a proportional amount according to their investment in the business.
This assumes that all of the shareholders own the same type of shares, but there might be times that a company wants to pay them in a different way. Creating different classes of shares, sometimes called alphabet shares, allows a company to do this.
What are alphabet shares?
The term ‘alphabet shares‘ describes the different classes of shares that can be issued by a limited company. Each class of shares (A shares, B shares, C shares and so on) can be assigned different rights. These could be voting rights, or the percentage of dividends that the shareholder of that particular class of share is entitled to.
For instance, an ‘A share’ shareholder might be paid dividends at a different rate to a ‘B’ shareholder. A ‘C’ shareholder may not have the same voting rights as a ‘B’ shareholder. This means that you could have a variety of shareholders with very different dividend payouts and voting rights.
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What are the benefits of paying different dividends out?
If you’re just dividing by share ownership, the benefit is that it’s a fair and simple way of dividing company profits. But what about alphabet shares?
Using different classes of shares means that a limited company can be more flexible in the way it pays out dividends.
It lets the company move beyond a pro rata basis of ownership, and instead pay shareholders based on their involvement or investment in the company.
You might want to appoint family members as shareholders but not give them voting rights. For instance, if you have children that you would like to receive dividends, but they don’t need to make decisions about the business.
Or, you might invest in a startup and own the majority of it without being involved in day-to-day operations. In that case, it might be agreed that the other directors will receive a larger share of the profits, whilst you still own most of the company.
Creating alphabet shares can become really useful in this sort of situation, giving you more control over who can influence the business.
What does this mean for tax?
Shareholders who receive dividend payments may need to pay Dividend Tax on this type of income. The amount of income they receive in a tax year, and the amount of dividends they earn, affects how much Dividend Tax they need to pay.