Alphabet Shares in a Contractor Company: When They Work

Alphabet shares work in a contractor company where the second shareholder is your spouse or civil partner and holds a real ordinary share: full rights to capital on a winding up, votes, and income, given outright with nothing coming back to you. That is the arrangement the House of Lords looked at in Jones v Garnett (the Arctic Systems case) in 2007, and the reason it survived was the spouse exception now in ITTOIA 2005 s.626. They fail where the second class is a dividend-only strip with no capital rights, where the shareholder is your unmarried minor child, or where dividend waivers are used year after year to push profit to one class that the reserves could never have supported across every class. The arithmetic driving all of it is the 2026/27 dividend position: a £500 allowance, then 10.75% in the basic-rate band and 35.75% above £50,270.

What problem are alphabet shares solving?

They solve a banding problem, not a company law problem. A single-shareholder contractor company pushes every pound of distributed profit through one person's dividend bands. Once that person is through the personal allowance and the basic-rate band, every further pound of dividend is taxed at 35.75% in 2026/27, up from 33.75% before 6 April 2026. A second shareholder with unused personal allowance and unused basic-rate band pays 10.75% on the same pound. Separate classes exist so the board can declare different amounts on each holding rather than being locked into the same dividend per share.

That is the whole commercial attraction, and it is also why the structure attracts scrutiny. If the only reason the second person holds a share is the rate difference, you are relying on an exception rather than on substance.

When do alphabet shares hold?

They hold where all of the following stay true, in every year a dividend is declared and not only on the day the share is issued.

Condition	What it means in practice
Spouse or civil partner	The s.626 exception is available only between spouses and civil partners. No other relationship has it.
Outright gift	No conditions, no right for the share to come back to you, no arrangement under which you benefit from it.
Full rights, not income only	The s.626 exception is lost where the property given is wholly or substantially a right to income. A class with no capital entitlement is exactly that.
Dividends actually theirs	The money reaches their account and they use it. Dividends routed straight back to an account you control undermine the gift.
Reserves support the declaration	Distributable profits cover every dividend declared, class by class, with the board minutes and vouchers to show it.

How does the settlements legislation actually bite?

It taxes the income back on you. ITTOIA 2005 s.624 treats income arising under a settlement as the income of the settlor alone where it arises during the settlor's life from property in which the settlor has an interest, and s.625 defines that interest widely enough to catch most arrangements where a spouse might benefit. The word settlement is not limited to trusts: it reaches any arrangement carrying an element of bounty, and a share in a profitable company transferred for a pound is bounty.

The exception in s.626 is what rescues the ordinary spouse case, and it carries two requirements. The first is that the gift carries a right to the whole of the income. The second is that the property is not wholly or substantially a right to income. A properly constituted ordinary share meets both. A class engineered to receive dividends while ranking for nothing on a winding up meets the first and fails the second, which is the most common way a contractor company gets this wrong.

Where do alphabet shares fail?

In the share class, in the shareholder, in the waiver and in the size of the dividend. Those four account for most of the failures.

• Income-only share classes. Articles drafted so the B class receives dividends but ranks for nothing on a winding up. This is the second requirement failing, and there is no route round it other than fixing the articles.
• Minor children. ITTOIA 2005 s.629 treats income paid to or for the benefit of an unmarried minor child of the settlor as the settlor's income, subject to a £100 a year limit. Alphabet shares never work for children under 18.
• Waivers propping up the split. A dividend waiver used repeatedly, where the distributable reserves would not have covered the same dividend per share on all classes, points at bounty rather than at a commercial decision.
• Disproportionate dividends to a passive holder. A large, regular dividend on a small holding by someone with no involvement in the company invites the question of what the share is really for, and outside the spouse exception there is nothing to answer it with.

How much does the split save at 2026/27 rates?

The saving is the gap between the two people's dividend rates on the transferred slice, and nothing else. With a £500 dividend allowance each, dividends taxed at 10.75% in the basic-rate band and 35.75% between £50,270 and £125,140, moving £20,000 of dividend from an upper-rate contractor to a spouse with no other income saves somewhere between 25 percentage points and the full 35.75% on each pound, depending on how much of it lands in the spouse's unused personal allowance, dividend allowance and basic-rate band. The whole amount still sits below £50,270 in the spouse's hands. Moving the same £20,000 to a spouse already earning £60,000 saves nothing. Corporation tax is unaffected either way, since dividends come out of post-tax profit: the company still pays 19% below £50,000 of profit, or the main rate with marginal relief above it, as set out in the guide to corporation tax for a contractor limited company.

Run the numbers on your own salary and dividend mix before restructuring anything, using the contractor salary and dividend calculator and the detail in the director salary and dividend split guide.

What should you do before issuing a second class?

Start by checking the other person's income for the year, because that decides whether there is any saving at all. Then look at the articles: the second class needs full ordinary rights, not a dividend strip. Document the gift properly, with a stock transfer form and a board minute, and keep the dividend paperwork for every declaration with the reserves position behind it. Do not build the plan around waivers. If the second shareholder also works in the business, paying a commercial salary alongside the dividend both reflects reality and can open up the Employment Allowance, which a company whose only employee is a single director cannot claim.

Read the articles, the transfer and the dividend history as one file rather than as three documents, because the settlements question turns on the arrangement as a whole. The dividend rate rise on 6 April 2026 widened the gap this planning exploits, and the wider gap is precisely why the substance has to be there. For the underlying rates and bands, see dividend tax rates for contractors in 2026/27.