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Father, aged 64, and son, aged 36 are 50/50 shareholders in two limited companies. The son has three children aged 8, 11 and 14. Father and son wish to divest themselves of some of their interest in the two companies by way, say, of issuing non-voting 'B' shares for the benefit of the children. This would involve an increase in share capital.
Readers' comments are requested on the inheritance tax, capital gains tax and income tax implications of this suggested plan, which may involve the formation of a settlement.
Father, aged 64, and son, aged 36 are 50/50 shareholders in two limited companies. The son has three children aged 8, 11 and 14. Father and son wish to divest themselves of some of their interest in the two companies by way, say, of issuing non-voting 'B' shares for the benefit of the children. This would involve an increase in share capital.
Readers' comments are requested on the inheritance tax, capital gains tax and income tax implications of this suggested plan, which may involve the formation of a settlement.
(Query T15,895) – M.G.S.
A full answer could easily run to several pages and therefore the comments below can only give a flavour of the main points to consider. For simplicity it is assumed that if a trust is used, the sole beneficiaries will be the children. Given their ages, one wonders whether in practice giving shares directly to the children (even if non-voting) would actually be a good idea.
Capital gains tax
Disposal of shares to a trust or directly to the children will create a capital gains tax liability based on the market value of the shares.
If the shares are in an unquoted trading company (section 165, Taxation of Chargeable Gains Act 1992) or the transfer is to a discretionary trust (section 260) then gift relief could be claimed by both the father and the son to avoid the capital gains tax liability. This would, however, reduce the base cost of the shares for the recipients.
The father is over 50 and may therefore be entitled to some retirement relief depending on the time he has held the shares. There are two limited companies and therefore 'M.G.S.' should consider whether they form a commercial association such that the 'full-time' requirements for retirement relief can be met (section 163(3)). This relief takes priority over gift relief and therefore when combined with taper relief and his annual exemption, it may be better for the father not to make a gift relief claim. The merits of a disposal pre and post 5 April 2002 should be considered in the light of higher taper relief but lower retirement relief as it is phased out.
Is the company likely to be sold in the near future? If so, it is important to remember that the taper relief clock (whether business or non-business) is reset to zero on the transfer. Thus the recipients could end up with lower net proceeds than if the father and son retained the shares and made the disposals themselves before giving cash to the recipients.
If the children own the shares directly or via a bare trust, they will effectively gain the benefit of their own annual exemptions and lower tax rates on any future gain.
Within a trust the rate of tax on capital gains is 34 per cent. On transferring shares out of the trust to the children it may be possible to claim gift relief. Any such transfer would again reset the taper relief clock.
If there is not a direct transfer of shares to the children or a trust, but rather a new issue of shares at less than market value, the father and son would still be treated as making disposals for capital gains tax purposes due to the value shifting provisions. The Inland Revenue Capital Gains Manual at paragraph CG13240 confirms that gift relief can apply to a deemed gain from a value shift.
Income tax
All of the children are minors. Consequently if the income from parental dispositions (such as dividends) is in excess of £100 per annum per child, the whole income is treated as the parent's income. A bare trust is no longer effective to prevent this charge.
If the shares are held by a discretionary or accumulation and maintenance trust, the rate of tax is 34 per cent. On dividend income, the trust rate is 25 per cent of the dividend grossed up for the 1/9 tax credit. Partial tax relief is given at the difference between the trust rate and the basic rate for revenue expenses of the trust. For an interest in possession settlement, the rate is 22 per cent with no further liability on dividends.
Section 660B, Taxes Act 1988 treats income paid by a discretionary or accumulation and maintenance trust to or for the benefit of the settlor's minor children as being income of the settlor.
Inheritance tax
If existing shares were transferred, it would be unlikely that there would be an immediate inheritance tax liability either because of business property relief, or because it will be a potentially exempt transfer (assuming it is not to a discretionary trust).
In the event of death within seven years of the gift, the property would still need to be held by the recipients or replaced with other property to ensure that business property relief is available.
If new shares are issued at a discount to market value, the father and son will be treated as having made dispositions as a result of section 98, Inheritance Tax Act 1984. It is important to note that such a disposition cannot be treated as a potentially exempt transfer, due to section 98(3). Whilst the nil rate band may be available to set against the charge, business property relief may not be available because the transfer of value has not actually been of shares. If the transfer of shares is to a discretionary trust, in the future there may well be ten-year charges and exit charges on the trust.
The son seems to be very young to be overly concerned by inheritance tax on shares. If he were to die now, there is in any case unlikely to be any inheritance tax payable due to business property relief. It must be remembered that even such 'tame' transfers produce legal and economic effects. By transferring part of his interest, he is permanently giving up access to the funds represented by the shares. Given his age, one wonders whether this is a wise move.
For the father also, there should be no inheritance tax on the shares on his death. As a pre-death transfer may either result in a capital gain, or a low base cost for the children, retaining his full holding until death would give the children a higher base cost and avoid any capital gains tax. – Wentworth.
Some retirement relief continues to be available to the grandfather but accurate planning supposes sufficient confidence in the necessary share valuations. A bonus issue of non-voting 'B' shares to father and son would cause some of the value in their existing shares to pass into them. Gifts of 'B' shares could be made by the grandfather direct to the grandchildren for them to enjoy the income tax free, or to a trust for their benefit such that the settlement anti-avoidance provisions would not apply.
Presumably dividends will be paid on the shares. The trustees or other donees might pay sufficient term insurance premiums to cover the inheritance tax risk of the grandfather's premature death.
If there is a longer term intention to sell the companies, it may be desirable to form a shareholders' agreement and perhaps keep the shares in a pool, as in Booth v Ellard [1980] STC 555.
Although the father cannot provide his children with tax-free income, he could place their shares in a bare trust and so escape the capital gains tax otherwise arising on maturity of an accumulation and maintenance settlement. See 'The Bare Bairns' by Ralph Ray (with precedent of a deed) in Taxation, 14 September 2000 at pages 622 and 623. – Elder.
Editorial note. A gift of shares by the children's parents would trigger the income tax settlement provisions in section 660B, Taxes Act 1988 so that the income could not be paid out without falling into charge as income of the parents; the High Court, Chancery Division decision in Butler v Wildin [1989] STC 22 suggests that those provisions can still apply where a subscription for shares is made on behalf of children with their own funds and the parents work for the company without payment (although that does not seem to be the case here). Note that minors cannot themselves subscribe for shares as they lack legal capacity to enter into contracts.
