Happy together: Family company shareholdings

Peter Rayney looks at key considerations when structuring shareholdings in a family company. 

Companies are often set up in a hurry, with no real thought being given to the commercial and tax efficiency of their shareholding structures.  

For various personal reasons, some family company ‘owners’ prefer to hold all the shares. As far as they are concerned, this gives them ‘total control’. In practice, overall control can be enjoyed by holding at least 75% of the voting rights since this would enable the ‘owner’ to pass special resolutions, vary its constitution and put it into liquidation. For effective day-to-day control, such as the appointment and removal of directors, determination of remuneration and dividend policy, it is only necessary to hold more than 50% of the shares. 

Sharing control 

Owner-managers may be prepared to share effective ‘control’ with their spouses and family trusts (of which they can be ‘first named’ trustees). This can often be beneficial for many tax reasons, including dividend extraction (see below).  

If the owner’s adult children or other close family members play an active part in the business, serious consideration should be given to them having some shares. Gifting shares in this way should motivate them and perhaps reward their contribution to the increase in the company’s value created by their efforts. This will also aid the ‘succession planning’ process and, of course, the psychological impact can be a significant factor.  

Transferring shares in a trading company by way of gift should normally be a relatively benign event from an inheritance tax (IHT) and capital gains tax (CGT) viewpoint (provided business asset hold-over elections are made). However, there may be IHT costs where the transferor shareholder dies within seven years of gifting shares, unless 100% business property relief is available on the failed potentially exempt transfer.  

In most cases where shares are gifted to close family members, there should be no ‘employment income’ tax charge due to the exemption in ITEPA 2003, s 421B for ‘shares made available in the ‘normal course of domestic, family, or personal relationships’. 

A word of warning; owners should aim to keep the company’s shares tightly held between ‘trusted’ family members and possibly key management team members. All too often, proprietors end up regretting their (or their parents’) decision to issue shares to certain family members (usually to satisfy some emotional obligation!). This can be especially problematic when these family members become ‘difficult’ or feel disenfranchised.  

Owner’s financial security and likelihood of a future sale 

Many family company owners view the business as a way of building up their financial security. When the time comes for them to step down and hand over control, the company should have provided them with sufficient funds for their future requirements. The owner can obtain ‘independent’ financial security by taking sufficient remuneration, dividends and by ensuring appropriate pension provision is made throughout their ‘working life’. For many, this equates to maximising the number of shares held.  

If the owner-manager’s main objective is to build up the company for a future sale, they should ensure that they have sufficient shares to achieve the desired level of the future sale proceeds. The vast majority of owners wish to access the beneficial 10% business asset disposal relief (BADR) rate of CGT on an exit or winding-up (which is available on the first £1 million of gains).  

Proprietors should ensure they maintain a qualifying shareholding to enable a competent BADR claim to be made when the need arises. Shareholders (who must be officers or employees of the company) qualify for BADR provided they own at least 5% of the ordinary share capital, carrying at least 5% of the voting rights and at least 5% economic rights throughout two years before the share sale or cessation of trade.  

Owners with substantial equity should take special care where the company has different classes of shares. The definition of ‘ordinary share capital’ is extremely wide, and shares with minimal economic rights can sometimes have an adverse dilutive impact on the key shareholder’s BADR eligibility (as demonstrated in McQuillan v HMRC [2017] UKUT 34 and Castledine v HMRC [2016] UKFTT 145. 

Dividend extraction 

Tax considerations are also an important driver, ensuring that shareholders can access key tax reliefs and are able to extract appropriate value through dividend payments. The owner-manager will usually require a substantial holding or perhaps a separate class of shares to satisfy their personal financial needs (through dividends).  

It is worth noting that with the corporation tax rate increasing to 25% from April 2023 for many companies, the current tax advantage of taking dividends over bonuses is likely to disappear in many cases. 

Example 1: Bonus v dividend (2023/24) 

Gareth owns all the £1 ‘A’ ordinary shares in ‘his’ family company, Three Waistcoats Ltd. He anticipates paying annual bonuses of around £100,000. Gareth reckons the £100,000 would be fully taxed at 40%, and his salary exceeds the upper limit for employee’s National Insurance contributions (NICs).  

He is looking at the respective tax costs of paying £100,000 as a bonus, compared to a dividend for the year ended 31 March 2024 (assuming corporation tax at 25% but all other tax and NIC rates remaining the same). 

* £88,945 less secondary NICs threshold £8,840 (2021/22) = £80,105 

** Dividend of £75,000 less £2,000 dividend ‘nil rate’ band 

Dividend payments to family members 

Where the owner’s spouse (or civil partner) has little income of their own, it will often be beneficial for the spouse or civil partner to hold some shares to obtain an appropriate level of dividend. Even when corporation tax is increased, there should still be a reasonable tax saving due to the 7.5% lower dividend tax rate. 

This is best done by issuing the appropriate number of ordinary shares to the spouse or civil partner on formation of the company, or the owner-manager subsequently gifting some ordinary shares to them.  

Providing shares to a spouse or civil partner for little or no consideration will invariably be a settlement. Nevertheless, provided the shares contain the full bundle of rights (i.e. voting, capital and dividends), the transfer of the shares would fall within the ‘outright gift exemption’ rules in ITTOIA 2005, s 626. This ‘turns off’ the spousal settlement rules, and hence the relevant dividends would be taxed in the spouse’s hands, as demonstrated by the ruling in the Arctic Systems case (Jones v Garnett [2007] UKHL 35). It is recommended that a spouse receives the dividend in their own bank account. 

Spousal or civil partner shares can be re-categorised as a separate class (whilst retaining the same rights), which will provide greater flexibility with future dividend levels. 

Example 2: Dividend paid to spouse (2021/22)  

Gareth’s wife, Alison, owns all the £1 ‘B’ ordinary shares in Three Waistcoats Ltd (see Example 1). 
In the year ended 31 March 2022, it is agreed that a dividend of £52,000 will be paid on her £1 ‘B’ ordinary shares. 

A dividend of £52,000 is tax-efficient since this only incurs a tax charge of £2,807, as shown below. This is considerably less than the tax cost that would have arisen if Gareth had received it. 

Shares can also be provided to other family members to provide dividend income to them. However, the payment of dividends to minor children of the owner-manager (settlor) is likely to be caught by the parental settlement rules in ITTOIA 2005, s 629. Importantly, in such cases, there is no equivalent of the ‘outright gifts’ exemption (see above). Thus, the dividend income would be taxed in the settlor-parent’s hands.  

On the other hand, dividends paid on shares held by adult children are not caught by these rules. Consequently, a highly effective strategy is to transfer shares to children after they have reached their 18th birthday. In these cases, dividends paid to children can benefit from their personal allowances and 7.5% basic rate dividend tax bands. Parents who require a greater level of control over income passing to their children should consider using a family trust. 

Practical tip 

Even in the context of a family company, a shareholders’ agreement is recommended to ensure there is clarity around the shareholders’ rights and obligations to each other, how exits are dealt with, dividend policy and so on.