What to consider when giving away shares in the family company

One of the most popular and effective ways of estate planning is making lifetime gifts, but any lifetime gift may have tax and other consequences.  In this article for Insider Media, Simon Mitchell looks at some of the points to consider when you are thinking about giving away shares in the business you or your family have built up.

What should you think about when considering lifetime gifts of company shares?

Factors that may influence a gift include the tax consequences of making that gift. The two main taxes to consider are Inheritance Tax (IHT) and Capital Gains Tax (CGT).

Looking first at IHT, you will want to ensure that the shareholding qualifies for 100% Business Relief (BR) from IHT.  There is more information on which shareholdings qualify in an article here.  One advantage of making a lifetime gift of shares which qualify for BR is that you are locking in the current IHT relief – by the time a shareholder dies, reduced rates of BR may apply alongside more onerous qualifying conditions.

Developments within the company may also suggest that an early review of share ownership is a good idea.  A trend in the business from trading towards investment may mean that BR cannot be relied upon as a tax-efficient means of passing capital to younger generations.  The same is true where there is a strong probability that the company will be sold or liquidated before the present shareholders die. At that point the shareholder is likely to hold cash, or other assets which don’t qualify for BR, so an earlier gift could allow the shareholder to take advantage of the relief available on that type of asset.

Where a shareholder has children who may become involved in the business, it’s important to think about succession planning.  This means considering what stake they should ultimately acquire in the business, and the process by which this should happen. In all these cases lifetime gifts, appropriately timed and structured, can help to manage an important transition, and give those involved the best chance to lock into the existing, relatively favourable BR regime.

What type of lifetime gifts are there? Can company shares be placed into a trust?

You can give shares away outright. The recipient will take subject only to the restrictions and conditions set out in the company’s articles of association and the terms of any shareholder agreement. Those shares will then be in the recipient’s estate for IHT purposes, but will also be at risk should they divorce or become bankrupt.

A gift to a trust provides the donor (the person gifting the shares) with greater security and control.  Voting rights attaching to the shares will be exercisable (in the best interests of beneficiaries) by the trustees, who may include the donor.  This avoids  fragmentation of ownership as well as the potential for conflict between those family members who participate in the business and those who are not.

There are different types of trust  (see this article) and the donor will decide, when setting up the trust, who should be able to benefit, and on what terms.  However, the life interest structure is likely to be the preferred choice.  This gives an income stream (to the extent that dividends are declared) to one or more specified individuals. It can be attractive for simplifying administration, while maintaining complete flexibility as far as the trustees are concerned.

Trusts also have an element of ongoing compliance (such as registering with the Trust Registration Service, and possibly needing to file tax returns).

Do lifetime gifts change the amount of Inheritance Tax (IHT) you pay?

A gift to an individual is a Potentially Exempt Transfer (PET) with no upfront IHT charge.  Gifts into trust are chargeable, but no IHT will arise if 100% BR applies, or to the extent that any unrelieved value is covered by the donor’s unused nil rate allowance. Lifetime trust creation is usually restricted to the amount of the IHT threshold to avoid a 20% entry charge on the excess.  BR will enable a donor to set aside significantly more valuable assets within a trust for the benefit of the wider family.

If the donor survives either kind of gift by seven years the shares will have been successfully taken outside of their estate.  This assumes no reservation of benefit in what has been given away.  For example, the donor’s ongoing remuneration from the company should be in line with their management duties and justifiable commercially.  Nor should the donor attempt to secure favourable pre-emption rights.

Where the donor dies within seven years of the gift, BR can still provide exemption from IHT.  This is dependent on the shares still being owned by the recipient when the donor dies.  If the recipient has disposed of the shares, BR will be denied or restricted.  These claw back rules are more severe for a failed PET than for a lifetime transfer to a trust, including their impact on the nil rate allowance that could otherwise be available to offset the donor’s residual assets.  For this reason it will often be preferable for gifts of shares to be gifted into trust.

The trustees will determine when and how to pass on shares (or the proceeds of sale or liquidation) to specific family members.  While assets remain under the trustees’ control they will be within a very low IHT environment, even when the qualifying conditions for BR can no longer be satisfied.

Do lifetime gifts affect your Capital Gains Tax (CGT)?

It is usually possible to defer a CGT tax charge on accrued capital gains on gifts of unquoted trading company shares.  When the gift is to an individual, business asset hold-over relief should be available.  This may be restricted where the company owns chargeable non-business assets.

In contrast, it should be possible to claim full CGT deferral where the gift is to a trust of which the donor (or their spouse) is not a potential beneficiary.  If the shares are subsequently transferred out of the trust to family beneficiaries, further hold-over relief may be claimed.  This means that gains are either realised on a future disposal by the beneficiaries, or extinguished when they die.

The drawback to a lifetime gift of shares to a trust is the loss of the CGT uplift at the donor’s death (which happens to all assets owned at the date of death).  Clearly, for a company which is likely to trade until the shareholder’s death, any loss of this advantage should be carefully considered.  However, if loss of BR is a distinct possibility (whether because of the future of the company, or changes to the tax regime), lifetime gifts are attractive.  The absence of a CGT – free uplift on death should be measured against the IHT saving at a higher rate on the full unrelieved share value.

In addition, any CGT analysis should take stock of Business Asset Disposal Relief (BADR).  A 10% rate now applies to a lifetime allowance of £1 million of qualifying gains.

Holding over gains on a gift to an individual, or to the trustees of a life interest trust, does not preclude a claim for BADR on a later disposal of the trading company shares by the recipient or the trustees.  This is so long as the individual recipient, or life tenant beneficiary, works in the company and satisfies the conditions as to 5% ordinary share ownership and voting rights over the requisite period of time.  If the relief can be made available to a number of individuals and trusts, carefully planned lifetime giving may offer considerable CGT benefits, particularly in those situations where a sale or liquidation of the company is most likely.

What else should I think about?

Ideally, any gifts of shares in a family company would be considered as part of a wider estate planning exercise, which would look at your entire estate, and how best to achieve your aims both in terms of passing on assets, but also protecting your and your family’s future.  Tax often plays a part in those considerations, and you will doubtless be aware of rumours that the government may make changes to both the CGT and the IHT regime.  We will find out more in October, but bear in mind that any changes may come into effect from the date of the Budget. Other considerations might include how to preserve the company for future generations, and how to protect vulnerable family members.

If you have any questions about the topics raised in this article, please get in touch.