Give shares to your partner – or not?

Alan Pink considers potential reasons for transferring shares in your company to your partner, and whether this should be by way of gift or ‘sale’.

 

One of the features of the UK tax system which differentiates it from some other countries’ systems is the fact that each individual is charged to tax as such; that is, there is no allowance made for the household as a whole. 

 

It is well known that, as a result, a household in which there is one earner can pay far more tax than a household where the same amount of income is spread between two earners. So, basic tax planning involves considering whether the income can be spread more evenly between the couple. 

 

In what follows, I’m going to assume that we’re talking about a business run through a limited company, in which an individual owns 100% of the shares currently. The actual situation is often more complicated than this; however, this scenario makes it easier to illustrate the principles. 

 

Robert owns all the shares in Trading Enterprises Ltd, which makes a pre-corporation tax profit of £200,000 a year. Robert is a fairly profuse spender on his personal lifestyle and takes out the whole of the post-corporation tax profit as a dividend. So, the dividend each year (after corporation tax) is £162,000, on which the income tax payable by Robert is over £50,000. By transferring 50% of the shares to his wife, Robert reduces the average tax rate to about 20% and saves income tax of getting on for £20,000. 

 

In that example, the transferor and the transferee of the shares were married. But does it make any difference to the basic principle if they are a couple living together who are not married (and are not civil partners)? 

 

Paradoxically, from an income tax point of view, it could actually make it easier. There are rules which impose certain conditions on transfers of shares between spouses if the diversion of income to the recipient spouse is to be effective. Basically, the transfer must be such that you are not giving them something which is ‘substantially a right to income’. So, transfers of shares whose rights are restricted (e.g. rights to vote or to receive capital on a sale or winding up) can be dangerous where the transfer is between spouses, whereas it would not be between the members of an unmarried couple. 

 

However, the essential difference is not, generally speaking, in the income tax effect but in the treatment of the transfer for capital gains tax (CGT) purposes. 

 

The crucial difference which arises from the question of whether or not the ‘partners’ concerned are married or in a civil partnership is that transfers between spouses and civil partners are treated as taking place at such a value as will give rise to neither a gain nor a loss for CGT purposes. In short, CGT isn’t a problem at all with such transfers. 

 

By contrast, where the couple isn’t married, the transfer is treated as taking place at open market value. The last thing anyone would want to do, in order to save income tax each year for the foreseeable future, would be to trigger potentially a very large CGT charge now.

 

If you make a gift of shares, you would have thought that the main tax enemy would be inheritance tax; which, after all, was first introduced (as capital transfer tax) to levy tax on gifts. But actually, under the modern tax regime, CGT on gifts can be far more of a problem. And this is where a little history lesson might help to make things a lot clearer. 

 

When CGT was first introduced (or at least since 1980) there was what was known as a ‘general relief for gifts’. What this set of rules stated was that although, prima facie, a gift or other transfer between connected persons was treated for CGT purposes as taking place at market value, there was a facility for the transferor and the transferee jointly to elect for ‘hold over relief’ to apply. This ‘relief’ had the effect of deducting the capital gain from the transfer value that was treated as taking effect, so that the transferee was effectively to be treated as acquiring the asset concerned at the transferor’s original base cost. 

 

The gain was thus deferred until such time as the transferee sold the asset concerned for cash. But this very sensible relief was abolished many years ago, and generally applies now where the transfer is between individuals, to transfers of business assets such as the shares in a trading company. 

 

So, that’s fine if your company qualifies as a ‘trading’ one for CGT purposes. But some companies, of course, don’t so qualify. It’s not just the out-and-out investment companies (e.g. companies set up to hold investment property portfolios) that are denied trading status for CGT hold over relief purposes. Companies whose activities, although possibly mainly trading, include investment activities as well to a ‘substantial’ extent, are also denied the relief. The word ‘substantial’ is a notoriously vague one, but HMRC interpret this as meaning ‘20%’ – although the question ‘20% of what?’ is one that they don’t explicitly answer.

 

You might think, however, that our 100% shareholder can avoid the CGT issues involved in transferring shares to a non-spouse/civil partner, in a company which doesn’t or may not qualify for hold over relief, by simply arranging for the company to issue some new shares to the intended recipient. Does this get around the problem because the current owner isn’t actually disposing of any of his shares? 

 

Unfortunately, the answer to this question is ‘no’. Almost as if the legislators have thought of this wheeze, a provision has been included in TCGA 1992 to the effect that, if a person who has control of a company exercises that control in such a way as to cause value to pass out of that current owner’s shares and into other shares in the company, this is treated as a disposal of the existing shares.

 

So, the intention (at least) of the rules is to bring about the same result where new shares are issued as where existing shares are transferred. One needs to consider, just the same, the question of whether or not hold over relief is available.

 

There’s also a particularly nasty set of rules to consider where anyone who is an employee or director of a company receives shares at a value which is less than their full market value. On the face of it, this could actually give rise to an income tax charge on the recipient under the dreaded ‘employed-related securities’ rules. 

 

However, in most situations where we are talking about transfers between members of the same household, particularly couples, this will not actually be a problem because the transferor’s issue of shares will be treated as taking place because of the love and affection between the transferor and transferee rather than because of any employment status that the transferee might have with the company.

 

In the light of all the above, what the issue comes down to, in the case of companies where CGT hold over relief is available, is the question of whether you actually want to trigger a capital gain or not. 

 

A gift of shares is eligible for hold over relief, but a sale of shares, of course, is not because you can’t hold over a gain where actual consideration has been received. So, a sale triggers a capital gain, up to the amount of the sale proceeds at least, regardless of whether the company is a trading company whose shares qualify for hold over relief. 

 

You might want to trigger a gain, to that extent (for example) in order to use an available annual exemption or, in a year in which your tax rate is low, a low rate of CGT. Alternatively, you might want to trigger a gain if entrepreneurs’ relief is available and you fear, or foresee, that it will not be available on a future disposal of the same shares.