Mark McLaughlin looks at rent-a-room relief and how a family company can be used to utilise the relief.
Family company owners with offspring aged 18 and over who are living at home might find that payments from their children for their upkeep come in very handy, particularly during times of rising household bills.
Could the family company be used as a tax-efficient source of funds for the adult children to fund the payments of upkeep to their parents? Quite possibly, it could.
For example, a combination of family company dividends to the adult children and ‘rent-a-room’ relief could provide a possible solution in certain circumstances.
Share and share alike
In the above example, if the parents are the only shareholders of the family trading company (say, 50% each), consideration might be given to redesignating their shareholdings as ‘A’ shares. If a bonus issue of ‘B’ shares was approved, the parents might then gift ‘B’ shares to their offspring (say, son and daughter, both of whom are at University) and claim capital gains tax gift relief (if necessary), with the parents retaining the ‘A’ shares.
Subsequently, if dividends are voted on the ‘B’ shares, the children may each be able to utilise their annual dividend allowance (£2,000 for 2022/23) and personal allowances (£12,570 for 2022/23) if not used elsewhere. The balance would be liable at the dividend tax rates. The net income could be put towards making rent payments for upkeep to their parents and possibly towards course fees.
Rent-a-room relief
How would the rent payments for upkeep be treated in the parents’ hands? Normally, rent received by individual landlords is liable to income tax. However, the rent-a-room scheme might enable all or part of the offspring’s rent to be received tax-free by their parents.
The rent-a-room scheme broadly allows owner-occupiers to receive tax-free rental income if furnished accommodation in the UK is provided in their only or main home. The annual rent-a-room limit is £7,500 (for 2022/23). This reduces to £3,750 if a joint owner (e.g., spouse or civil partner) receives lettings income from the same property. If gross receipts are less than £7,500 (or £3,750), the parents (in the above example) would be automatically exempt from tax on that income.
If gross receipts exceeded £7,500 (or £3,750), the parents could choose how they wish to calculate their tax liability using alternative methods. Under the first method (method A), tax is payable on actual profits (i.e., total receipts less any expenses and capital allowances). The alternative method (method B) provides for the tax liability to be based on gross receipts over the rent-a-room limit (i.e., gross receipts minus £7,500 (or £3,750)) but without deducting any expenses or capital allowances.
HMRC will automatically use method A to calculate the taxpayer’s liability. HMRC must be notified (i.e., within one year of 31 January following the end of the tax year) if the taxpayer wishes to use method B instead.
Don’t ‘settle’!
Care needs to be taken with tax planning arrangements involving ‘alphabet’ shares (i.e., shares with different classes) and the payment of dividends.
For example, the ‘settlements’ anti-avoidance rules mean it is generally unwise for parents to gift shares to offspring who are minors; if dividends are paid on the gifted shares, the income is taxable on the parents if the dividends exceed £100 in the tax year (this limit applies per parent if shares were gifted by both parents).
‘Funny’ shares (e.g., ordinary shares with rights removed or changed) may also attract unwanted attention from HMRC.
Practical tip
It is important to ensure that any reclassification of the company’s shares or any changes to the company’s shareholdings is dealt with correctly. In addition, any dividends must comply with company law requirements. Expert professional assistance should be sought, if necessary.
