HMRC's Settlements Legislation: The Risk with Alphabet Share Structures

HMRC's settlements legislation can tax dividends paid on alphabet shares as the income of the person who gave the shares away, rather than the shareholder who receives them, whenever the arrangement is not a genuine outright gift. Alphabet shares are separate classes of ordinary shares, usually labelled A, B and C, that let a company declare a different dividend on each class, which is why alphabet shares in a limited company UK structure are popular with family businesses. Blue Tick Accountants, a Guildford-based UK tax advisory and accountancy practice, reviews these structures for directors who want to use a family member's lower tax band without inviting an HMRC enquiry. This guide explains how flexible dividend shares work, where the settlements rules in Part 5, Chapter 5 of the Income Tax (Trading and Other Income) Act 2005 apply, how the Jones v Garnett case changed the position for spouses, and what the tax at stake looks like in 2026/27. For the mechanics of the share classes themselves, see our guide to alphabet shares and flexible dividend planning.

Key Takeaways

• The 2026/27 dividend rates are 10.75% ordinary, 35.75% upper and 39.35% additional, with a £500 dividend allowance, so moving dividends from a higher-rate to a basic-rate shareholder can save up to 25 percentage points.
• HMRC's settlements legislation, in sections 619 to 648 of the Income Tax (Trading and Other Income) Act 2005, can tax dividends on the person who made the settlement instead of the shareholder.
• Section 626 protects dividends from an outright gift of shares between spouses or civil partners, but not where the gift is wholly or mainly a right to income.
• Where a parent gives shares to an unmarried minor child, the parent is taxed on that child's dividends above £100 gross a year under section 629.
• Splitting £40,000 of dividends equally between a director with a £12,570 salary and a spouse with no other income saves £1,980.02 of tax in 2026/27.

How do alphabet shares work in a UK limited company?

Alphabet shares let a limited company pay different dividends to different shareholders from the same profits, because each class of share carries its own dividend right. A director might hold A shares and a spouse hold B shares, so the board can declare £30,000 on the A shares and £10,000 on the B shares in the same year instead of paying every shareholder the same amount per share. The classes must be created in the articles of association, and each dividend must come from distributable reserves, supported by board minutes and a dividend voucher for every shareholder. The flexibility is lawful under company law, but the ability to steer income towards the lowest tax band is exactly what attracts HMRC's attention. It matters most when a shareholder has unused personal allowance or basic rate band, and our article on salary and dividend strategy for 2026/27 shows how those bands interact with director pay.

What is HMRC's settlements legislation and when does it apply?

HMRC's settlements legislation is a set of anti-avoidance rules that tax income arising under a settlement on the person who made it, and a settlement includes any arrangement or transfer of assets that provides someone with income. A gift of shares that carries dividend rights can therefore fall within the rules. The key exception is section 626, which says income from an outright gift between spouses or civil partners is not treated as the donor's, provided the gift is not wholly or mainly a right to income. In Jones v Garnett [2007] UKHL 35, the House of Lords held that a spouse's ordinary shareholding in a husband's company was an outright gift within that exemption, so the dividends belonged to the spouse for tax purposes. HMRC has since accepted that ordinary shares with full rights to income, capital and votes qualify, while arrangements built to move income alone remain open to challenge.

Which alphabet share arrangements carry the most risk?

The highest-risk arrangement is a gift of shares that carries dividend rights but no meaningful rights to capital or votes, because section 626 does not protect a gift that is wholly or mainly a right to income. Three situations attract most scrutiny. First, shares given to a spouse, civil partner or adult child that are stripped of capital and voting rights, or where the money flows back to the donor. Second, shares held by a minor child: where a parent makes the gift, section 629 taxes the parent on the child's dividends above £100 gross a year, and the spouse exemption does not apply to children. Third, dividends declared that do not follow the rights in the articles, or paid without enough distributable reserves, which can be unlawful distributions that may have to be repaid. Each of these turns a lawful planning tool into an HMRC dispute.

What does a worked example look like in 2026/27?

In 2026/27, splitting £40,000 of dividends equally between two shareholders saves £1,980.02 compared with paying all of it to one director, using the rates in force from 6 April 2026. Assume the director takes a £12,570 salary, so the personal allowance is already used, and the company declares £40,000 of dividends. The spouse has no other income and holds B shares that are a genuine outright gift with full rights.

If the director takes all £40,000, the first £500 is covered by the dividend allowance, £37,200 is taxed at 10.75% (£3,999.00) and the remaining £2,300 falls into the upper rate at 35.75% (£822.25), a total of £4,821.25.

If each takes £20,000, the director pays 10.75% on £19,500 after the allowance, which is £2,096.25. The spouse's personal allowance of £12,570 covers the first part of their dividends, the £500 allowance covers the next, and £6,930 is taxed at 10.75%, which is £744.98. The combined bill is £2,841.23. The saving only holds if the spouse genuinely owns and keeps the dividends.

How can you set up alphabet shares safely?

A safe alphabet share structure starts with a genuine, documented gift of shares that carry the same capital and voting rights as the donor's shares, not an income-only slice. Use a stock transfer form, update the register of members and file the confirmation statement. Pay each dividend into the recipient's own bank account, and make sure they control the money. Declare dividends strictly by class under the articles, minute each declaration and issue vouchers. Check distributable reserves from up-to-date accounts before every declaration. Be aware that a gift to an adult child is a disposal for capital gains tax at market value, while a gift between spouses is no gain, no loss. Take advice before issuing shares to a minor, because section 629 can undo the benefit.

Frequently Asked Questions

What are alphabet shares in a limited company?

Alphabet shares are separate classes of ordinary shares, usually called A, B and C shares, that each carry their own dividend rights. They allow a limited company to declare different dividends on each class from the same profits, which gives directors flexibility to pay family shareholders different amounts without changing who owns the business.

Can I pay dividends to my spouse through alphabet shares?

Yes, if your spouse owns shares under a genuine, outright gift that is not wholly or mainly a right to income. Section 626 of the Income Tax (Trading and Other Income) Act 2005 then treats the dividends as your spouse's own income, taxed at their rates, with a £500 dividend allowance in 2026/27.

Do HMRC's settlements rules apply to dividends paid to children?

Yes. If a parent gives shares to an unmarried minor child, the child's dividends above £100 gross a year are taxed on the parent under section 629. The spouse exemption does not extend to children, so alphabet shares for under-18s rarely achieve a tax saving.

Are alphabet shares still worth using in 2026/27?

They can be, because the gap between the 10.75% ordinary dividend rate and the 35.75% upper rate is 25 percentage points in 2026/27. The saving is only secure where shares are a genuine outright gift, dividends follow the articles and distributable reserves support every payment.

How Blue Tick Can Help

Blue Tick Accountants advises limited company directors on share structures, dividend planning and settlements risk, so every gift of shares is documented and defensible before the first dividend is paid. Blue Tick reviews your articles of association, shareholdings and dividend history, then shows you the saving that is realistic. Head to our website and book a meeting now.

Conclusion

Alphabet shares remain a legitimate way to direct dividends to family shareholders with spare tax bands, but the settlements legislation means the gift behind the shares must be real. An outright gift of shares with full rights between spouses is protected by section 626, whereas income-only shares and parent-to-child gifts are not. With the 2026/27 upper dividend rate at 35.75%, the saving is worth having and worth defending. Review your articles, check who truly owns and receives each dividend, and document every declaration before relying on the structure.

About the Author

This guide was written by Leon, founder of Blue Tick Accountants, who advises limited company owners, landlords and the self-employed across the UK on tax planning and compliance. It was last reviewed for the 2026/27 tax year, using HMRC guidance and the legislation cited above.

This article is intended for general informational purposes only and does not constitute tax, legal, or financial advice. Tax rules are subject to change and their application will depend on your individual circumstances. You should always seek advice from a qualified professional before taking action. Blue Tick Accountants accepts no liability for decisions made on the basis of this content.

Related reading: Including a Spouse as a Shareholder: Alphabet Shares in a UK Limited Company.

Related reading: Family Company Dividend Planning: Allocating Profits with Alphabet Shares in a UK Limited Company.