Does giving children shares now save you tax in the long term?

October 28th 2019

Your long-term plan is for your children to take over the family company but they are far too young at the moment. Nevertheless, is it worth giving them shares in the business now as a tax-saving measure? Brona MacDougall advises.

For almost as long as income tax has existed, parents have tried different ways to mitigate their tax bills by diverting income to their minor children. Invariably, these schemes usually fail because of HMRC’s wide ranging anti avoidance rules known as ‘the settlements legislation’. The effect is that parents remain liable to tax on income derived from assets, unless the income per child is less than £100 per year such as in cash, stocks, shares etc. which they have transferred to their children.

Diverting profits
While the anti-avoidance rules prevent you from shifting the tax bill on dividends by transferring shares to your children, there might still be tax advantages to it. The first point to note is that while you’ll pay tax on your children’s dividends this doesn’t increase your tax bill as you would have had to pay tax on them anyway. What’s more, giving away shares now can save you tax later.

On reaching 18 (or marrying at 16 or 17) the settlements legislation ceases to apply. That means you’ll no longer be liable to pay the tax on dividends paid to your children.

James is a higher rate taxpayer. His fledgling company issues a small number of shares to his two children (aged 5 and 8), say 5% of the company’s ordinary share capital each. The dividends paid on these are taxable on James. When each of his children reaches 18 they become liable to tax on the income. Both children go into further education, they can use the dividends they receive from the company to help fund them through university. If they didn’t have this, James would have to fund them from his taxed income. Assuming the children have no other income, the tax saving would be significant.

Because of early tax planning James has provided a source of tax-free money for his children for when they reach 18. To make the planning flexible, James’ company could issue alphabet shares to the children, e.g. a different class of ordinary shares from those owned by him. This would allow the company to pay dividends at different rates to each shareholder.

Capital gains tax saving
If James were to sell or wind up his company, part of the proceeds would be payable to his children as shareholders. Any resulting capital gain would be taxable on them even if the sale/winding up occurred when they were minors. The children are each entitled to an annual exemption to reduce their capital gains tax bills.

Giving shares to your young children can save tax when they reach 18 because the tax anti-avoidance rules which apply to gifts to minors cease to apply. They can use their own tax allowances to reduce the tax payable on dividends they receive instead of you funding them from your taxed income.

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