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What are alphabet shares and why do small companies use them?

Alphabet shares are separate classes of ordinary shares (A shares, B shares, C shares, and so on) in the same company, each of which can be paid a different dividend at a different time. They let shareholders -- often a director and their spouse or business partners -- receive different dividend amounts without waivers, but HMRC scrutinises arrangements that look purely tax-motivated.

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Alphabet shares (also called alphabet share structures) divide a company's ordinary share capital into separate classes -- typically A Ordinary, B Ordinary, C Ordinary and so on -- each carrying the same basic rights (voting, capital on winding up) but allowing the directors to declare a different rate or amount of dividend on each class independently. **Why companies use them** Without separate share classes, dividends on ordinary shares of the same class must generally be paid at the same rate per share -- you cannot simply decide to pay one ordinary shareholder more per share than another of the same class in the same declaration. Alphabet shares solve this by giving each shareholder (or group of shareholders) their own class, so the company can pay, say, a large dividend to A shares in one year and nothing to B shares, then reverse this the following year, depending on the shareholders' individual tax positions and cash needs. **Typical use case** A common scenario is a company owned by a director and their spouse, each holding a different alphabet share class. If the spouse has little or no other income and unused Personal Allowance and basic-rate band, the company can pay a larger dividend to the spouse's share class and a smaller (or nil) dividend to the director's class in a particular year, reducing the household's overall tax bill compared with paying dividends strictly pro rata. **HMRC scrutiny -- the settlements legislation again** As with dividend waivers, HMRC can apply the settlements legislation where alphabet share arrangements look like a way for one spouse to divert income to another spouse who is not fully economically involved in the business, purely to secure a tax advantage. The key defence, established in the Arctic Systems (Jones v Garnett) House of Lords case, is the outright gift between spouses exemption: if the shares themselves (not just the right to income) were genuinely gifted between spouses or civil partners, and the shares are not simply a right to income (they carry real capital and voting rights), the arrangement usually falls outside the settlements rules. **Practical safeguards** To reduce risk: ensure alphabet shares carry genuine rights beyond just dividend income (voting rights, entitlement to capital on a winding up), keep proper company records (board minutes declaring dividends by class, updated register of members), and avoid dividend waivers stacked on top of alphabet shares purely to further skew the split -- combining the two techniques attracts more attention. **Worked example** A company has A shares (held by the director, a higher-rate taxpayer) and B shares (held by their spouse, who has no other income). The company declares a £15,000 dividend on B shares only in a year when the spouse's income would otherwise be well under the Personal Allowance. The spouse pays no Income Tax on the first slice covered by the Personal Allowance and then 8.75% (basic rate) on the rest above the £500 dividend allowance, rather than the director paying 33.75% or 39.35% if the same amount had been paid to their own A shares. **Company law and admin** Creating alphabet shares requires updating the articles of association (or adopting model articles with a share class structure), issuing the new share classes correctly, and filing the appropriate forms at Companies House. A qualified accountant or company secretarial provider should set this up correctly from the outset.