In another article we considered how to leave private trading company shares by will. However, there may be good reasons to make lifetime gifts of such assets. This article explores some of the implications.
When to think about lifetime gifts
The first requirement is to ensure that shareholdings qualify for 100% business relief (BR) from Inheritance Tax (IHT). The relevant factors were considered in the article or gifts by will. It should be borne in mind that, 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 desirable. 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 will be true where there is a strong probability that the company will be sold or liquidated before the present shareholders die.
Where a shareholder's children are already involved in the business, there will be a requirement for careful 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 enable an important transition to be managed, and give those involved the best chance to lock into the existing, relatively favourable BR regime.
Principal types of gift
Shares may be given outright. The donee 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.
A gift to a trust will provide the donor with greater security and control. Voting rights attaching to the shares will be exercisable (in the best interests of beneficiaries) by agreement of the trustees, who may include the donor. In this way, fragmentation of ownership can be avoided, along with the potential for conflict between family members participating in the business and those who are not.
The entitlement of beneficiaries will depend on how the trust is worded to reflect the donor’s particular wishes. 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.
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 his or her estate. This assumes no actual or imputed reservation of benefit in what has been given away. For example, the donor’s ongoing remuneration should be commensurate with his or her 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 operate to secure effective exemption from IHT. This depends on the shares remaining in the ownership of the donee at the date of death, whether or not then classifiable as relevant business property for IHT. However, if the donee 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 which may be available to offset the donor’s residual assets. For this reason it will often be safer for gifts of shares to be effected via a 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 their control they will be within a very low IHT environment, even when the qualifying conditions for BR can no longer be satisfied.
Capital Gains Tax (CGT)
The ability to defer a tax charge on accrued capital gains means that CGT should not generally be a problem with gifts of unquoted trading company shares. When the gift is to an individual, business asset hold-over relief will be relevant. This can, however, be restricted where the company owns chargeable non-business assets.
In contrast, full deferral may be claimed where the transfer is to a trust which is not settlor-interested. If the shares are subsequently moved out of the trust into the hands of family beneficiaries, further hold-over relief may be claimed, so that eventually gains are either realised on a future disposal by the beneficiaries or extinguished when they die.
The drawback is the loss of CGT rebasing at death, when gains to that date effectively fall away. Clearly, for the company which is likely to trade until the shareholder’s death, any loss of this advantage will require careful assessment. However, if loss of BR is a distinct possibility, lifetime gifts will remain 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.
Moreover, any CGT analysis must take stock of entrepreneur's relief. A 10% rate now applies to an extended lifetime allowance of £10 million of qualifying gains.
Holding over gains to an individual, or the trustees of a life interest trust, does not preclude a claim for entrepreneur's relief on a later disposal of the trading company shares. This is so long as the individual donee 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.
See also: Owner-managed businesses: tax-efficient wills for company directors