Your company is doing well and you’re considering giving some shares to your young children – but how should you proceed, avoiding trouble with HMRC?
Tax planning v tax avoidance
Of course, tax avoidance is frowned upon even if it’s within the rules. However, that shouldn’t put you off from organising your tax affairs efficiently. Giving your children a share of your business is a good example of this. For many years HMRC has had robust anti-avoidance rules to prevent abuse of this sort of arrangement. If you can avoid falling foul of these rules no one, including HMRC, should have anything to complain about.
If you do transfer shares in your company to your young children, who are under 18 (or 16 and unmarried), anti-avoidance rules known as the “settlements legislation” apply to any dividends paid on them. The effect of the legislation is to treat the dividends as your income for tax purposes. This means there’s no immediate tax advantage to the arrangement, but there can be in the longer term – which is why it’s tax planning and not avoidance.
Planning for the longer term
When your children reach 18 (or 16 and married) the settlements legislation ceases to apply. This means dividends on your children’s shares will no longer be taxable on you. Instead they are officially part of your children’s taxable income. Therefore, instead of having to dip into your savings to bail out your youngsters while they are at university or travelling, you can pay them a tax-efficient dividend instead.
Tax saving benefits
The tax saving is achieved if you pay higher tax rates on dividends compared to those your children. Unless they have significant other income they’ll have a dividend nil rate band (assuming it still exists by then) and basic rate band available to minimise the tax on the dividends.
The shorter-term plan
Bearing in mind that you’ll pay tax on your children’s dividends until they reach 18 (or 16 and married) you have two options. Either accept the tax bill (which wouldn’t be any more than if you had kept the shares and received the dividends in your name) or create one or more separate classes of shares. The latter will allow you to defer paying dividends until your children become liable for the tax on them, i.e. when they reach 18 (or 16 and married).
Consider Capital Gains Tax
Where you give your children some of your shares, or create a new class of shares and allot them to your children, HMRC will treat the transaction as if you had sold part of your company. This might result in a capital gains tax (CGT) bill.
A good tip for this is to give shares to your children while your company is relatively young and hasn’t built up profits. The value of any shares will therefore be relatively low, meaning CGT liability is kept to a minimum. Or where you create a new class of shares, consider making them shares with no voting rights and perhaps with a fixed rate of return. The advantage of this is they generally have a value around par, which avoids tricky valuation arguments with HMRC and makes the CGT predictable.
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