Child’s income – Or is it?

 

Parents sometimes wish to gift income-bearing assets (e.g. company shares) directly to their unmarried minor children, to take advantage of the child’s personal allowance (and dividend allowance) and possibly also their basic rate income tax band, to reduce the family’s overall tax burden on dividend payments. 

 

Unfortunately, this tax planning idea is generally blocked by anti-avoidance rules. 

 

Those rules (i.e. the ‘settlements’ legislation) broadly provide that in the above circumstances dividends on the gifted shares fall to be treated for income tax purposes as income of the parent(s) if the total dividends paid to the child for the tax year exceed £100 per donor parent (ITTOIA 2005, s 629).

 

The settlements rules are commonly associated with trusts but are much wider; they can catch ‘any disposition, trust, covenant, agreement, [non-charitable loan] arrangement or transfer of assets’ (s 620(1)). A settlement must contain an ‘element of bounty’ (IRC v Plummer [1979] STC 793), such as a gift or transfer at less than full value. 

 

HM Revenue and Customs (HMRC) indicates (in its Trusts, Settlements and Estates manual at TSEM4110) that where a person (the ‘settlor’) enters into an arrangement that he or she would not have entered into with someone at arm’s length, the arrangement is susceptible to the settlements rules.

 

HMRC’s guidance features examples of the settlements rules in the context of parents and minor children (see TSEM4300). 

 

In Mr & Mrs Bird v Revenue and Customs Commissioners [2008] SpC 720, the taxpayers (Mr and Mrs Bird) were the shareholders of their kitchen furniture company, owning one share each. The company issued a further 98 shares at par; 19 shares each to the taxpayers, and 20 shares to each of their three minor daughters. Dividends were paid to all the shareholders. HMRC argued that dividends paid to the daughters (until they reached age 18) constituted income arising under a settlement, which should be treated as the taxpayers’ income.

 

The Special Commissioner concluded that the taxpayers had made an ‘arrangement’ for their minor daughters to acquire a 60% equity stake in the company and that there was ‘bounty’ in the arrangement. The taxpayers’ appeal in respect of the settlements provisions was dismissed.

 

What if the children paid full value for their shares? HMRC might argue that the relationship of parent and child is such that arrangements between them must always involve an element of bounty (e.g. see the comments of Nourse J in Harvey v Sivyer [1985] STC 434). In any event, the children’s funds for the shares must not originate from the parents, but from another source (e.g. a gift from grandparents). 

 

The parents should also consider ensuring that they are remunerated at a commercial rate for their work in the business (it is assumed here that the children do not work in the business).

 

Dividends paid to minors following a share transfer by their parents may be challenged by HMRC. It might be easier simply to wait until the child reaches 18 before any dividends are paid.