I am often asked by clients if they can add their wife, husband, partner, mother, father (even aunt or uncle) as a director to pay them dividends from their limited company. As ever, the answer is….it depends! 
Firstly, it is important to understand the difference between a directors and a shareholder. 

Shareholder 

A shareholder is effectively an owner of the company. 
 
The amount of shares they hold determines how much of the company they legally own and control. 
 
A company can have different types of shares and those share types can have different levels of control and voting rights. 
 
Shareholders are entitled to dividends from profits made by the company. The amount they are entitled to is determined by the proportion of shares they hold. If they hold 80% of the shares, they are entitled to 80% of the profits/dividends. 

Director 

A director is a manager of the company.  
 
Directors are in charge of the day-to-day running of the company. They set the business strategy and make decisions on behalf of the company to move the business towards its ultimate goals. 
 
Directors are also responsible for ensuring that the company meets its statutory obligations i.e. filing of accounts and settling tax liabilities. Directors have a legal obligation to act in the best interests of the company at all times. 
 
 
In a small company, there is often just one or two directors, who are also shareholders. 
 
To pay dividends to a family member they will need to be added as a shareholder. 

How does it work? 

Dividends should be paid in proportion to the number of shares the shareholders own. So, if you own 50 Ordinary Shares each, each time the company pays a dividend, each shareholder should receive 50% of the total dividend. 
 
If you want to pay a specific or different amount to a shareholder, the simplest solution is to set-up alphabet shares. Alphabet shares allow you to have different types of shares and therefore pay different shareholders different amounts of dividends.  
 
This ensures flexibility. 
 

How much could you save? 

If you were to pay a spouse (or other person) just £2,000 a year in dividends (utilising the dividend allowance), you could save £150 - £650 in income tax per year (based on 2016/17 tax thresholds and rates). Most limited company owners will find the savings closer to £1,625 per year. 
 
There are more potential savings available if you can justify a larger amount payable to your family member. 

Are there any pitfalls? 

Care needs to be taken to ensure that you are not caught by the Settlement Legislation and therefore attract attention from HMRC. The Settlement Legislation, put simply, is anti-avoidance legislation to target people who arrange to divert their income to avoid tax, or to pay tax at a lower rate. 
 
To guard against this, if the family member doesn’t actively work within the company, we would usually advise against them holding more than 20% of the shares. Giving more than 20% could leave you open to scrutiny from HMRC. 

Things to consider 

Before going ahead, there are several considerations to be made. 
 
1. Does the family member actively work in the business? 
 
If they actively work in the business, as explained above, it may be easier to justify the dividends. 
 
2. What are their current earnings from employment, property etc? 
 
It is important to determine whether they are a basic rate or higher rate tax payer to identify what the potential tax savings may be. 
 
3. How much dividend do you wish to pay and what proportion of the profits does this equate to? 
 
By considering how much you wish to pay them, we can look at the best share structure – whether to use standard Ordinary shares or perhaps make use of Alphabet shares. 
 
4. Are you aware of the other consequences of issuing shares? 
 
When family members become shareholders, they are not just entitled to dividends, they become legal owners of the company. It is vital that you understand this as although we all have the best of intentions, relationships can break down and this can become another asset to cause friction. 
Effective Accounting is a family business. My mum, Jill and sister, Natalie, work in the office and we know how important family is. We also know how every penny counts and we work proactively with our clients to make the numbers work for them. 
Next steps….get in touch to discuss. Drop us an email or give us a call. 
 
Remember: One size does not fit all, so it is vital that you speak to us and get tailored advice on this before proceeding. 
 
 
 
 
Written by: 
 
Nicola J Sorrell -  
Effective Accounting 
 
Founder | Xero Champion | IR35 Expert 
 
 
Tagged as: Tax Savings
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