OCL Accountancy – Gifting shares and saving tax on company profits

To prevent parents gaining a tax advantage by shifting income to their children HMRC has tough anti-avoidance rules. Is there legitimate tax planning that company owners can use to work around them?

For decades schemes have been devised to shift profits from company owners to their minor children in an attempt to save tax. Typically, they involve a company owner transferring some of their shares to their children. HMRC can’t prevent the transfer, but it applies tough anti-avoidance rules (the settlements legislation) to prevent any income tax advantage.

Trap. The settlements legislation makes the parent liable to tax on the income, e.g. dividends, arising from the shares (or other assets) gifted to their minor children. As well as the settlements legislation separate capital gains tax (CGT) anti-avoidance rules cause the gift of shares to be treated as if it were a sale at market value, i.e. the amount an unconnected third party would pay. If this is more than the shares cost the transferor, the difference is a taxable capital gain.

Think long term: Despite these anti-avoidance rules, giving shares to your children can produce tax savings – you just have be patient. While your children are minors and you pay the tax on the income (dividends) paid to them, you’ll be no worse off in tax terms than had you not transferred the shares. The tax magic happens when your children cease to be minors, which is usually on their 18th birthday. The income tax anti-avoidance rule ceases to apply and your children will then be taxable on the dividends.

Tip: While they are minors consider investing the money on your children’s behalf tax efficiently, say in a Junior ISA.

Options for adult children: When your child becomes 18 they have a number of options. They could continue to receive dividends to give them income on which they pay little or no tax, depending on whether they have other income. Alternatively, they might turn the shares into a cash lump sum.

Example: In December 2023 Sarah gives her one-year-old son, Jo, shares in her company with a market value of £3,000. The shares cost Sarah £3 when she started the company. The anti-avoidance rules means Jo is taxable on a capital gain of £2,997 but as this is less than her annual CGT exemption there’s no tax for her to pay. By the time Jo reaches 18 and goes into further education the accumulated dividends plus growth amount to £50,000. Jo sells the shares back to Sarah, or possibly to Sarah’s company. The resulting CGT would be around £5,500 (assuming tax rates stay the same and Jo has little or no other income). This would leave him £44,500 to help with his tuition, etc.

Tip: The tax plan works best if you give shares to your children while your company is relatively new or even at formation. That way their market value is likely to be relatively low, so you can give more away without triggering a CGT bill.

While your child is a minor the anti-avoidance rules apply, so giving shares to them doesn’t save any tax. But the rules cease to apply when they reach 18. From that point you have effectively shifted income to them. This could provide your youngsters with a low tax income or a capital sum just when they need it, say to help with further education.

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