Many family companies have been trading for generations. Shares are often gifted when parents are approaching retirement, and wish to pass the business reigns to their adult children. Alternatively, parents may wish their children to have some of the company’s shares and possibly receive dividends to help fund further education.
The potential tax implications of gifting shares between parent(s) and adult child (e.g. father to son) should not be overlooked. This article outlines some important points to consider. An alternative to gifting shares might be for the company to issue new shares to the children, but the tax implications of that arrangement are not considered here.
Gift or reward?
If the son (in the above example) works for the company, it needs to be considered whether the gifted shares are employment income. If so, there could be income tax and National Insurance contributions implications. For example, there may be a charge on general earnings (under ITEPA 2003, s 62), under the ‘employment related securities’ provisions (s 421B(1)), or possibly under the ‘disguised remuneration’ rules (Pt 7A).
To constitute the son’s employment income, the shares would have to be received by reason of his employment with the company. It is a question of fact whether the company’s shares are being gifted by reason of the son’s employment, or family relationships. Even though father may only be passing the business on to his son for family reasons, there still needs to be sufficient evidence to establish or support that fact, to reduce the risk of challenge by HM Revenue and Customs (HMRC).
For capital gains tax purposes, the above gift of share from father to son will be treated as a disposal at market value (TCGA 1992, s 18). If the shares are standing at a gain, it may be important to consider whether a gift relief claim is available (under s 165) to ‘hold over’ (i.e. defer) the gain. Care is needed. For example, the company must be a trading company (or the holding company of a trading group). In addition, gift relief may be restricted if the company has chargeable non-business assets, such as investment property (Sch 7, para 7).
For inheritance tax (IHT) purposes, a gift from one individual to another is a potentially exempt transfer, which becomes exempt if the donor survives at least seven years. If the donor dies within that period, the gift is a chargeable transfer, on which IHT may become due. Whether or not business property relief is available in respect of the shares may therefore be another important consideration.
Don’t get settled!
Following the gifting of the shares, the ‘settlements’ anti-avoidance rules may need to be addressed if the son is an unmarried minor, and dividends are paid on the gifted shares (ITTOIA 2005, s 629).
If the son is an adult, the settlements provisions may still apply to treat dividends as his father’s income if, for example, there are arrangements for the son’s shares to be returned to father (or mother), or for the son’s parents to benefit from the son’s dividend income (s 625).
Dividends may seem a tax-efficient way to extract profits from a company. However, if the son is a paid director or employee, HMRC may seek to tax dividends as general earnings (HMRC v PA Holdings Ltd  EWCA Civ 1414), or possibly under the employment related securities provisions (under ITEPA 2003, Pt 7, Chs 3B or 4) in certain circumstances, such as if the dividends are ‘disguised’ earnings.
HMRC is less likely to challenge dividends (in the above example) if the son’s shares are ‘plain vanilla’ ordinary shares, and he is already being paid a commercial rate of remuneration by the company for his work.
The above points are not exhaustive. A short article such as this can only touch upon some of potential tax implications to consider before passing shares to the next generation. Professional advice on the tax (and non-tax) implications should be sought where necessary.
The above article was first published by Business Tax Insider (September 2016) (www.taxinsider.co.uk).