It is fairly common, particularly in longer standing family companies, for shares to be passed down from one generation to another. For example, some shares may be gifted from father to son, where father is the managing director and majority shareholder in the company, and his son works for the company and is perhaps being groomed to take over the running of the business on his father’s retirement.
Family member gifting shares
Where an individual makes a gift of shares, the first reaction is possibly to consider whether there are any tax implications for the person making the gift.
Taking the example of father and son, a gift from father to son will be deemed to take place at market value for capital gains tax purposes (under TCGA 1992, s 18). If the shares are standing at a gain, it may be necessary to consider whether a holdover relief claim is available (under TCGA 1992, s 165). For inheritance tax 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, whether or not business property relief is available might become an important issue.
Family member receiving shares
So much for the person making the gift of the shares; what about the recipient’s immediate tax position?
In the example mentioned earlier, family company shares are being gifted from father to son, where the son is an employee of the company. Income tax is charged on employment income, which includes general earnings such as salary, wages, gratuities, amounts treated as earnings (e.g. benefits in kind), and any amounts which count as employment income, such as share related earnings (ITEPA 2003, s 7). For National Insurance purposes, ‘earnings’ include any remuneration or profit derived from the employment (SSCBA 1992, s 3).
It is therefore necessary to consider whether the shares constitute employment income of the son. If they are employment income, this could have income tax implications in a number of ways. 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’ provisions (Pt 7A).
By reason of the employment?
To constitute employment income, the shares would have to be received by reason of the son’s employment with the company. The tax and NIC legislation does not seem to offer much direct assistance in determining whether a gift of the shares from father to son is by reason of the employment, or by reason of the family relationship between them. For example:
- The general earnings charge under s 62 simply states that earnings must arise “in relation to an employment”.
- In the context of employment related securities, the legislation (in ITEPA 2003, s 421B(3)) states that a right or opportunity to acquire securities is to be regarded as by reason of the employment, unless the person by whom the right or opportunity is made available is an individual, and the right or opportunity is in the normal course of domestic, family or personal relationships. However, that legislation only deals with the application of the employment related securities provisions (in Pt 7, Chs 2 to 4A) and not (as mentioned) to the ‘general earnings’ charge.
- Elsewhere in ITEPA 2003, s 201(3) states that a benefit provided by the employer is ‘by reason of the employment’ unless the employer is an individual, and the provision is made in the normal course of the employer’s domestic, family or personal relationships. However, in our example of shares passing from father to son, the benefit is being provided by the father and not the company. In any event, s 201(3) only applies to residuary benefits not covered elsewhere in the legislation.
HMRC’s view
HMRC guidance does not offer very much assistance either, as it does not seem to cover instances of gifts similar to those in our example of shares passing from father to son. For example:
- First, in the context of the general earnings charge under s 62, HMRC guidance in the Employment Income manual (at EIM00610) warns that taxable earnings may be paid by someone other than the employer. It states that what matters is that the payment is made because the recipient holds the employment, or as a reward for services provided in the employment, and not for any personal reasons. On the other hand, HMRC states (at EIM01460) that a gift does not count as general earnings (under s 62) if it is made on personal grounds. However, it then adds that it is not possible to list factors that will determine with certainty whether or not a gift is taxable.
- Secondly, the Employment Related Securities manual confirms (at ERSM20220) that the exception for family or personal relationships (in ITEPA 2003, s 421B) mentioned earlier would clearly apply if father, on reaching retirement, hands over all the shares in his family company to his son and daughter simply because they are his children, even if they are both also employees of the family company. But HMRC then goes on to state that it is a question of fact, and it is possible for the employment, rather than the family relationship, to be the reason for the gift; where that is the case, the shares will be employment related securities.
- Thirdly, the Employment Income manual includes guidance on the ‘employment income provided through third parties’ legislation in ITEPA 2003, Pt 7A. It includes an example (at EIM45131) which considers whether arrangements involving shares in a family company come through the ‘disguised remuneration’ gateway in ITEPA 2003, s 554A.
One of the conditions for s 554A to apply is that a ‘relevant third person’ takes a ‘relevant step’ (s 554A(1)(d)). An individual or a trustee can be a ‘relevant third person’ for those purposes (s 554A(7)). However, the arrangements described in HMRC’s example involve a discretionary trust, where the settlor died some years ago and shares pass to the settlor’s children who are also employed by the company.
HMRC acknowledges in its guidance (at EIM45131) that it is quite normal for wealthy parents to pass their assets down the generations, and that discretionary trusts are often used for this purpose. HMRC therefore accepts that entering into such transactions for reasons of estate planning will not, of itself, take an arrangement through the disguised remuneration ‘gateway’ in s 554A. However, if the estate planning is combined with remuneration planning, then the arrangement will come through the gateway and be subject to the disguised remuneration provisions.
Points to consider
It is ultimately a question of fact whether father has gifted the family company shares to his son in our example because of family relationships, or by reason of the son’s employment (or both). Let us assume that father is only passing the business on to his son due to the family relationship. There still needs to be sufficient evidence to establish or support that fact. Otherwise, the gift may be open to challenge by HMRC as employment income, and ultimately it may be left for the First-tier Tribunal to decide on the tax treatment. To help determine that the shares are being gifted by reason of the family relationship, there are one or two points worth considering:
- Is there a history of shares in the company passing down the generations? If the company has been in existence for a long time, this may well be the case. A share register or list of share transfers may therefore be helpful.
- Is the recipient of the shares already receiving remuneration from the company at a commercial rate? If they were only receiving a small salary, HMRC would probably have more cause to argue that the shares were being gifted to them in order to ‘top up’ their remuneration package with the company. On the other hand, if they were already being paid a commercial salary, it would probably be more difficult for HMRC to establish a link between the gift of shares and their employment duties for the company.
- Is father in our example transferring shares only to son, or is he transferring some shares to other (non-family) employees as well? If father is transferring shares to a number of employees including the son, this would suggest that the gift from father to son was by reason of the son’s employment, in the same way as the gift of shares to the other employees was presumably by reason of their employment. On the other hand, if shares were being gifted to the son and other family members who are not employees, it would probably be reasonable to assume that the gift of shares from father to son was by reason of the family relationship.
- If (as in our example) the gift was by reason of the family relationship between father and son, it may be helpful if the share transfer was accompanied by a deed of gift, or possibly even a letter from father to son, explaining the reason for the gift.
Is that clear?
Finally, there may be borderline cases where the evidence is not conclusive one way or the other. For those cases in particular, a non-statutory clearance application to HMRC may be worth considering.
I dealt with a case recently where shares were being transferred from father and mother to their adult sons. All the family worked for the company. The parents were gradually withdrawing their involvement in the business, and allowing their sons to take over. The family wanted certainty on the tax treatment of the share transfers, so a non-statutory clearance application was made to HMRC, setting out the facts and the reasons for the gifts of shares to the sons. HMRC replied stating it was satisfied that the shares were being gifted by reason of the family relationships in the particular circumstances of that case.