Alphabet shares: how they work and the tax traps to avoid

If you own a company, alphabet shares let you create different classes of share, each with its own rights. They’re commonly labelled A, B, C and so on.

You might use one class for voting control and another for dividends. Different rights can also help you bring in an employee, attract investment or pass part of your business to the next generation.

Used well, alphabet shares give you valuable flexibility. Problems arise when the rights, tax treatment and company records don’t agree.

Adding a letter to a share doesn’t create its rights. Your legal documents do.

What are alphabet shares?

Section 629 of the Companies Act 2006 says shares belong to the same class when their rights are uniform.

In practice, you create alphabet shares by giving separate classes different rights.

Those differences might concern:

• Voting power
• Dividend entitlement
• Repayment of capital
• Participation in a sale
• Appointment of directors
• Treatment when a shareholder leaves
• Redemption or transfer of shares

For example, you could give your A shares full voting, dividend and capital rights. Your B shares might receive dividends but carry no vote.

Another company could use the same labels for a completely different arrangement. You need to look at your articles of association and terms of issue to understand what each class does.

Why might you use alphabet shares?

Your reasons should begin with a commercial need. Tax can influence the decision, but it shouldn’t be the only purpose.

1. Paying different dividends

Separate classes may allow you to pay different dividends to different shareholders. This can help when the owners of your company have different income needs.

Before making a payment, you must check your distributable profits and available cash. Your articles must also permit different dividends.

2. Bringing employees into your business

You may want to give an important employee a financial stake without handing over the same voting power as the founders.

This approach can support recruitment, retention and succession. It may also create employment tax and reporting obligations.

Depending on your aims, a formal arrangement such as Enterprise Management Incentive share options could be more suitable.

3. Separating investors from management

Suppose you raise £250,000 from an outside investor. In return, they want a financial return and protection over major decisions. They don’t want to run your business.

You could retain management control through A shares. Meanwhile, B shares might give the investor specific rights to dividends and sale proceeds.

Well-drafted rights can separate investment from day-to-day management. They must still reflect the deal you’ve agreed.

4. Planning your succession

You may want to give the next generation a share of your company’s profits and any future sale proceeds, while keeping control over important decisions.

Different share classes can separate those rights. Before you issue or transfer any shares, check how they’ll be valued and what tax each person may have to pay.

Can your alphabet shares receive different dividends?

Yes, they can – but two conditions must be met. Your share rights must allow different payments, and your company must have sufficient distributable profits.

Section 830 of the Companies Act 2006 allows dividends only from profits available for distribution.

Suppose your company has £100,000 of distributable profits. It also has 100 A shares and 100 B shares. Your articles allow you to declare a separate dividend on each class.

The directors decide to pay an interim dividend of £400 per A share and £200 per B share. This means:

• A shareholders receive £40,000
• B shareholders receive £20,000
• Distributable profits fall by £60,000

The different payments are possible because the two classes have separate dividend rights. If your articles and class rights don’t allow this, the letters alone won’t make the payment lawful.

Distributable profits aren’t the same as cash. Your company also needs £60,000 in the bank and enough left to meet its tax, payroll, supplier and other commitments.

You must then approve the dividend correctly. Under the model articles for private companies limited by shares, directors may decide to pay an interim dividend.

A final dividend works differently. Shareholders declare it by ordinary resolution after receiving a recommendation from the directors. They can’t approve more than the directors have recommended.

Whatever the type, record the decision and issue dividend vouchers showing the class and amount paid.

For more on taking profits from your company, read our guide to salary versus dividends for 2026/27.

Are alphabet shares tax efficient?

Not by themselves. Alphabet shares change your ownership structure, but they aren’t a tax relief.

They may form part of sensible planning. Their treatment depends on who receives them, why you use them and what rights they carry.

Four areas require particular care.

1. Giving shares to your spouse or civil partner

Settlements legislation can apply if you give away an asset but continue to benefit from its income.

An important exception covers some transfers between spouses and civil partners. Under section 626 of the Income Tax (Trading and Other Income) Act 2005, an outright gift falls outside the rules when:

• Its recipient receives all the income from the asset
• The asset isn’t wholly or substantially just a right to income

For this purpose, an outright gift can’t be subject to conditions. Nor can the shares, their value or related property be able to return to you.

An ordinary share with genuine capital rights may qualify. By contrast, a share providing little beyond dividend income may not.

Where the exception applies, dividends are normally taxed on the recipient. If it doesn’t, the settlements rules may attribute that income to the person who made the gift.

This distinction was central to Jones v Garnett, better known as the Arctic Systems case. HMRC’s guidance on gifts between spouses and civil partners explains its approach.

Being married doesn’t make your share arrangement safe. Both the rights and circumstances matter.

2. Giving shares to a spouse who works for your company

A second set of rules may apply if your spouse is also a director or employee.

Shares acquired because of a directorship or employment can fall within the employment-related securities rules. Your family relationship doesn’t automatically remove that risk.

HMRC recognises an exception for some shares provided through domestic, family or personal relationships. Whether it applies depends on your reasons for providing them.

If the real purpose is to reward your spouse for their work, the shares may still be employment-related. A direct allotment by your company needs particular care because the family exception concerns an opportunity provided by an individual.

Read HMRC’s guidance on the family and personal relationship exception for further detail.

3. Issuing shares to employees or directors

When you give alphabet shares to an employee or director, you may create an Income Tax charge. This risk arises if they pay less than the shares are worth.

You therefore need to establish a defensible market value.

For example, a restricted B share may be worth less than a fully participating A share. Even so, it could have considerable value if it carries generous dividend or sale rights.

You may also have reporting obligations. In some cases, you’ll need to register an employment-related securities arrangement with HMRC.

Once registered, your arrangement will normally require an annual return. This includes a nil return where applicable. The deadline is 6th July following the end of the tax year.

HMRC’s standing guidance explains the employment-related securities reporting requirements.

Current late-filing penalties include:

• Missing the deadline attracts £100
• Three months of delay adds £300
• Six months of delay adds another £300
• Nine months of delay may lead to daily £10 penalties

Late nil returns can attract the same charges. HMRC maintains separate guidance on ERS penalties.

4. Using dividends to replace salary or bonuses

Ordinary commercial dividends don’t become salary simply because a shareholder also works for your company.

HMRC has offered reassurance on this point. It won’t use these rules against a genuine owner-managed business paying normal dividends from profits. That position applies where there’s no contrived attempt to avoid Income Tax or National Insurance.

Compare that with an arrangement designed to replace employment pay.

Suppose your sales director would usually receive a £30,000 bonus. Instead, you issue them one low-value B share and pay a £30,000 dividend on that class alone.

Calling the payment a dividend doesn’t settle its tax treatment. HMRC may ask whether you transferred value in return for the director’s work.

Its guidance distinguishes ordinary commercial dividends from contrived arrangements used mainly to disguise cash bonuses.

The dividing line isn’t whether your employee receives a dividend. It’s whether the payment comes from a genuine investment or replaces remuneration.

How do you create alphabet shares in your company?

Changing your share structure involves more than editing a spreadsheet or producing a certificate.

1. Decide what you want to achieve

Start with your commercial goal.

A family succession plan may require one set of rights. An employee incentive or outside investment could need something quite different.

Tax belongs in your decision, but it shouldn’t be your only reason for changing the structure.

2. Define the rights clearly

Write down what each class is and isn’t allowed to do.

You need to answer questions such as:

• Who can vote?
• How will you decide dividends?
• What happens if you sell the company?
• Which class receives capital?
• When can shares be transferred?
• Can your company redeem or convert them?
• What happens when a shareholder leaves?

Include death, retirement and disputes in your planning. You may also need to update your shareholders’ agreementalongside the articles.

3. Choose between an allotment and a transfer

You can create new shares or transfer an existing holding.

An allotment increases your company’s issued share capital. As a result, it may dilute current shareholders’ percentages.

A transfer changes the owner of existing shares without increasing the total share capital.

If somebody buys shares through a stock transfer form, Stamp Duty may apply. The standard charge is currently 0.5% when the consideration exceeds £1,000, rounded up to the nearest £5.

Both the form and payment normally need to reach HMRC within 30 days of the stock transfer form being signed and dated. GOV.UK explains the Stamp Duty rules for stock transfer forms.

Gifts and other transactions may receive different treatment. Check your tax position before making the transfer.

4. Obtain the necessary approval

Section 550 of the Companies Act 2006 can let your directors allot shares without prior shareholder authority. This shortcut usually applies only if your private company will continue to have one class.

Once your allotment creates a second class, that route no longer works. The directors must have authority under section 551.

Your articles may already provide the necessary authority. Otherwise, you’ll need a shareholder resolution.

Changing the articles normally requires a special resolution. Existing class rights may need separate consent too.

5. Complete your records and filings

The required steps depend on whether you allot, transfer, redesignate or vary the shares.

Your work may include:

• Passing the relevant resolutions
• Revising your articles
• Filing amended documents
• Submitting form SH01 after an allotment
• Updating the register of members
• Producing new share certificates
• Recording each class’s rights
• Reviewing your persons with significant control position
• Completing employment-related securities reporting

For an allotment, you must file an SH01 return within one month. Section 555 of the Companies Act 2006 sets that deadline.

Changes to voting rights can also affect your company’s PSC position. Someone may become registrable by holding more than 25% of either the shares or voting rights.

Different voting rights may therefore change the answer even when everyone keeps the same number of shares. Companies House explains how to identify people with significant control.

Identity verification may create one further step. If a new shareholder also becomes a director, they’ll need to verify their identity before the appointment can be registered.

The paperwork isn’t an administrative afterthought. It’s your evidence that the new structure exists.

Years later, a buyer, investor or HMRC officer may ask what rights your shares carried when you issued them.

What happens when one of your shareholders leaves?

Alphabet shares often work well while relationships remain good. Trouble tends to arrive when somebody leaves, retires, dies or wants to sell.

Your articles and shareholders’ agreement should answer several questions:

• Must the departing owner transfer their shares?
• Who has the right to buy them?
• How will you calculate the price?
• Do the shares convert into another class?
• Which voting and dividend rights continue?
• Does good or bad leaver treatment apply?

Without suitable terms, a former employee may keep their holding and continue receiving dividends. You could also face a purchase price that your company or remaining shareholders can’t afford.

A thorough business valuation can help when you issue, transfer or buy back shares.

When are alphabet shares a bad fit for your company?

Sometimes the extra flexibility creates more trouble than value. Warning signs include:

• No clear commercial purpose
• Tax acting as your only reason for the structure
• Employee shares issued without a valuation
• Selective dividends replacing salary or bonuses
• Nobody agreeing what happens when an owner leaves
• An approaching investment or sale with unclear share rights
• Company records that don’t match your articles or shareholders’ agreement

Complexity should earn its place.

Need help with alphabet shares?

Alphabet shares can give you useful flexibility over ownership, control and dividends. To work properly, they need to form a complete structure.

Your commercial purpose, share rights, tax treatment and company records must support one another. A letter in your share register doesn’t do that work.

THP’s tax planning team can explain the consequences before you issue or transfer shares. Our company secretarial service can help with resolutions, records and Companies House filings.

Get in touch today before you make the change.