Passing On The Family Property Company Shares

Alan Pink highlights some planning points and pitfalls when shares in a property investment company are transferred between family members. 

Surprising though this may sound coming from a tax adviser, there’s more to life than tax, and one of the first things that need to be said, in the context of someone planning to give away shares in the family property investment company to other family members, is that you need think about the consequences of this in the non-tax sphere, as well as in the tax sphere. 

Consider the following straightforward scenario, where parents’ worst fears are fulfilled. 

Mother and father own all the shares in a fairly valuable property investment company. They decide to bring their only daughter into ownership of the shares and, therefore, transfer 20% to her. Unfortunately, she then gets married to a highly undesirable son-in-law, who duly begins a series of affairs which culminate in their divorce. Despite his undeserving position, the matrimonial court makes an award to him based on the value of half of the shares, which his now ex-wife was given by her parents. 

Of course, it’s not just in matrimonial proceedings that the recipient of valuable shares can endanger the overall family wealth; any kind of financial difficulty will do that. But, having made the above possibly fairly obvious point, as a commentator on tax issues I will have to leave it at that. Even if a transfer of shares is entirely motivated by tax considerations, ultimately the taxpayer/client himself will have to form his own view on the possible repercussions, or perhaps take advice from a suitably qualified lawyer if he can find one.

There are probably two main reasons why owners of property investment company shares might wish to pass some of them over to other family members, typically the next generation: 

A gift of shares, as of any other asset, will be effective in reducing the donor’s estate for inheritance tax (IHT) purposes after seven years (in the absence of any ‘reservation of benefit’). If the donor should, unfortunately, die within the seven-year period, but after at least three years have been notched up, the gift comes back into tax, but with tapering of the tax on the gift by 20% a year for each year after the third.

The lion in the path, of course, is capital gains tax (CGT). If you are talking about a property investment company rather than a trading company (which is what we are doing here) there is no CGT ‘holdover relief’ for a gift of shares to another individual. So, there is a deemed capital gain by reference to a disposal of that shareholding at its market value. 

This can even give rise to the dreaded ‘double whammy’, if you’re really unlucky, with CGT being payable on the gift, and IHT also being payable on the same gift if the donor fails to survive it by seven years. 

So, that’s the bad news. Whilst it may still be worth it, sometimes it’s a case of saving potential IHT at the 40% rate at the cost of paying CGT at the 20% rate. But the bad news can be somewhat tempered by the discounting rules of valuation, as in the following example. 

Mother and father own all the shares in Family Property Limited, a company whose assets comprise investment properties worth in total £1 million. Mother has 51% of the shares and father 49%. They decide to make a gift of 20% of the shares to their only son. 

Initially, the thought is that they will give 10% each, but their accountant suggests that the CGT could be somewhat mitigated if all the gifted shares come out of father’s 49% holding. 

Why? Because a 20% holding in a company is not worth 20% of the total, as this is a comparatively uninfluential minority holding, in most companies. As with any minority holding in an asset-based company, it’s customary to value the shares by taking the value of the company’s underlying assets and applying a discount to reflect the fact that this is a minority. 

The accountant, in this case, manages to agree with HMRC that an appropriate discount is 80% - and his main argument in agreeing this is the fact that there is still one other shareholder (mother) who, with her untouched 51% holding, exercises control over the company. If the shares had come from each, the 20% holding given to son would have had a much lower discount, possibly, because it would have held the ‘balance of power’.

In other cases, you may be able to make use of the principle that the valuation for IHT purposes can be different from that used for CGT. For CGT purposes, the shareholding which is given away is valued in isolation, on the assumption that an unconnected person is buying them. Because of the discounting rules, this can give quite a low value. However, for IHT purposes, the applicable principle is: how much has the donor’s estate gone down in value? 

For somebody who has (say) 51% of a company, with the others not being connected closely, a gift of as little as 2% (with a correspondingly low CGT value) makes the difference between controlling the company and not, therefore, the reduction in the value of the donor’s estate may be huge – at little CGT cost.

Use of trusts

The only situation in which property investment company shares can be given away without triggering CGT is where holdover relief is available by reason of it being a gift into trust. So, is this the solution to the CGT problem?

Unfortunately, the answer to this is ‘no’ in a large number of cases. The problem is that gifts into trust give rise to IHT where the value gifted into trusts exceeds the nil rate band (£325,000 per person currently) over an accumulative seven-year period. Very few taxpayers, in practice, elect to pay this ‘lifetime’ IHT charge. 

Sometimes, though, where the numbers work out, you can do a balancing exercise, as in the following example. 

Mr and Mrs Ponsonby own 50% of the shares, each, in Ponsonby Properties Limited, which has property assets recently valued at £10 million, with no significant liabilities. Mindful both of CGT and the vulnerability of shares to financial creditors they decide that, instead of making a gift of shares to their daughter Clarissa, they will put shares on trust for her instead. 

Balancing the wish to give away as much as possible and, therefore, save as much IHT as possible, with the wish to minimise CGT, they decide to give away 25% of the company to Clarissa. 

The value of the transferred shares for inheritance tax purposes is £1 million, but instead of simply gifting the shares to the trust they sell them to the trust for £350,000.

With a value for the transfer to trust of £175,000 each, they ensure that they are only bestowing ‘bounty’ on the trust of £325,000 each, meaning that there is no IHT charge. The capital gain which cannot be held over is based on their actual proceeds of £175,000 each which, given nominal original cost for the shares, results in tax of £35,000 each, which they consider an acceptable price to pay for the reduction in their inheritance taxable estates.