Mark McLaughlin highlights a potential Inheritance Tax trap when owner-managed company shares are gifted between family members.
It is common for shares in a family company to be passed down the generations. However, anti-avoidance rules dealing with ‘Gifts With Reservation’ (GWR) are a potentially nasty Inheritance Tax (IHT) trap.
Cake and eat it
The GWR provisions (FA 1986 ss 102-102C; Sch 20) are broadly designed to prevent an individual seeking to reduce their exposure to IHT by making a lifetime gift (which they hope to survive by at least seven years) whilst continuing to have the use or enjoyment of the gifted asset.
If ‘caught’ by the GWR rules, the gifted (or possibly substituted) property is generally treated as remaining part of the donor’s estate for IHT purposes.
Pass it on…
For example, shares in a family company often pass from parents to adult children where the parents are approaching retirement, and the children are stepping up from being employees to managing the company. The parents might remain involved with the company until their offspring are ready to take over.
Following the parents’ gifts of shares to the children, could HM Revenue and Customs (HMRC) argue that there is a GWR if the parents receive remuneration from the company?
As with many tax questions, the answer is ‘it depends’.
Let’s be ‘Reasonable’!
HMRC’s guidance indicates that if the parents received ‘reasonable’ commercial remuneration for their work in the company, and those arrangements continued unchanged after the gift of shares, there would be no GWR provided that their remuneration package was not linked to or affected by the gift.
On the other hand, HMRC states: ‘If, however, as part of the overall transaction, including the gift, new remunerative arrangements are made you will need to examine all the facts to determine whether the new package amounts to a reservation ‘by contract or otherwise’’ (see HMRC’s Inheritance Tax manual at IHTM14337).
Shares into Trust
Alternatively, instead of transferring shares directly to the children, the parent may transfer family company shares into trust in which the children (but not themselves) are beneficiaries. The gift into trust will normally be an immediately chargeable transfer for IHT purposes, so an IHT liability may arise unless (for example) the gift is subject to ‘business property relief’ at 100% or is covered by the parent’s ‘nil rate band’.
The parents (in this example) may wish to be trustees of the trust, so that they can exercise a degree of control over the shares in trust. Happily, HMRC’s published view is that the parents' also being trustees is not, of itself, regarded as a GWR. This applies even if the parents are entitled to payment for their service as trustees, provided any payments are not excessive. However, the parents as trustees must exercise the votes attaching to the shares in the interests of the beneficiaries (i.e. the children), and not themselves (IHTM14394).
The parents could also continue to receive remuneration from the company for their services as directors. However, if gifts of shares form part of arrangements involving new or adjusted remuneration packages, the GWR rules will need to be considered carefully.
The above article was first published in Tax Insider (www.taxinsider.co.uk).