Keep It In The Family

Planning for succession in a family company is never easy. It involves those who have run the company for many years considering how best to pass on the reins to those who are going to succeed them. Secretly, many business owners do not really believe that their children are going to be up to the job, whereas many of the younger generation think the business would take off if only their parents would stop holding it back!

The last thing you want to add to that complex mix is a tax problem, so here are five tips and traps to remember when transferring company shares.

While this does rather play into the hands of the dogs in the manger, dying while holding shares in an unquoted company normally has all the advantages and none of the disadvantages that arise with other assets. The advantage is the complete elimination of capital gains tax (CGT), as the shares are treated as sold and reacquired at market value but with no CGT liability. The normal corresponding disadvantage of an inheritance tax (IHT) bill is probably not going to arise when the shares are in an unquoted trading company, as business property relief will often eliminate the IHT liability. However, remember not to waste this by leaving the shares to a spouse (or civil partner) as part of an ‘all to my wife/husband’ will – use the exemption to pass the shares down one, or even two, generations.

Another reason why the owners of the company can be reluctant to pass them on to the next generation is that they have insufficient other sources of income or capital. Commenting that they should have thought earlier about pension provision may be correct, but it is rarely helpful. One way to get the best of both worlds, assuming that the younger generation already have a shareholding of their own, is for the company to purchase the shares from the older generation. The result is the same as if the shares had been passed on, but the older generation get a pay-out from the company.

Husband and wife Rajinder and Gurpreet own 60 shares in the family company where they are directors, worth £500,000. They built the company from nothing, so the shares have no base cost to speak of. Their two sons, Harjit and Jagdesh each own 20 shares. The company has at least £500,000 in distributable reserves.

If the company purchases the shares and cancels them, Rajinder and Gurpreet will each get £250,000 out of the company and should only pay CGT at 10% because of entrepreneurs’ relief, if certain conditions are satisfied. Harjit and Jagdesh will be left with a company that has diminished reserves, but they will now own the company outright in equal shares.

The conditions for a company purchase of own shares to give rise to a capital receipt as opposed to an income receipt (and also the company law requirements) need to be followed carefully. One of the attractions of it, from the younger generation’s point of view, is that those who are selling their shares normally need to retire from management, as that is given as the reason for the sale benefiting the company. This can be a useful way of politely telling Dad (and normally it is Dad) that it is time to back off! 

Whenever entrepreneurs’ relief is involved, it is very important not to leave employment too early. This came up in a recent case, Moore v Revenue & Customs [2016] UKFTT 115 (TC). Mr Moore fell out with the company he had helped to found, and it was agreed that he would leave, with his shares being repurchased by the company. The agreement was reached in February 2009, and the date of his resignation as a company director was stated to Companies House as 28 February. However, the share sale was finalised (as it had to be) by a special resolution of the company passed in May 2009. Because at that point Mr Moore was no longer an employee of the company, he was not an officer or employee for the twelve months ending with the disposal of his shares, and therefore did not meet the qualifying conditions for entrepreneurs’ relief.

Regardless of the method of share disposal, this point will be relevant if a gain arises and entrepreneurs’ relief is being relied on to reduce the CGT. For a company purchase of own shares it will be necessary to show that the selling shareholder is leaving, but there is no requirement for that to happen immediately, and in other cases the retirement of the shareholder need not be linked at all to the transfer of the shares. It is wise, therefore, to have clear and unambiguous documentary evidence that the shareholder is an employee or office-holder in the company right up to the sale. If the reality is that the shareholder wants to stop work before then, and there is only one shareholder to consider, the office of company secretary can be a useful one to give them – there is no longer any requirement for the company secretary to carry out any particular duties, as there is no longer any requirement to have one at all, but he or she is an office holder of the company.

A company’s shares only qualify for entrepreneurs’ relief if it is wholly or mainly a trading company – investment activities amounting to more than 20% can disqualify it. While this can be a real problem, the most common concern of most taxpayers is unlikely to cause difficulties in practice.

What most company owners worry about is that the cash they have accumulated will take them over the 20% limit. This is a particular issue for companies with low goodwill and other asset values where significant reserves have built up. When entrepreneurs’ relief first came in, there were warnings that if the cash in the company was more than 20% of its total value, relief could be denied.

In fact, the test is about activities, and there is a strong argument that simply holding cash on deposit is not an investment activity at all, or at most is a minimal one. It would be different if the cash was being actively managed, or if a managed investment portfolio was held, but simply having cash in a bank account has not, in practice, normally triggered an argument from HMRC.

One of the most drastic mistakes to make would be for the shares to be passed to a younger generation member working in the business, and for them to be treated as part of his remuneration, with corresponding liabilities to both income tax and National Insurance contributions. The potential for this to happen comes from the definition of an employment related security (in ITEPA 2003, s 421B(3)). This is a ‘you are caught unless’ provision, requiring the recipient to show that the shares have been acquired in the normal course of domestic, family or personal relationships.

HMRC guidance, at ERSM20220, confirms that they take a ‘common-sense’ view of the exemption, and that the normal process of transferring shares down the generations will not cause a problem. Worryingly, however, they add that ‘it is a question of fact, and it is possible for the employment, rather than the family relationship, to be the reason for the gift, and where that is the case the shares will be employment-related securities’. 

It seems that the main time this issue will arise is when shares are given to a number of employees, clearly as part of their remuneration package, and one of the employees is, say, the son or daughter of the owner. However, it would be wise to ensure that any inter-generational family transfer is clearly documented as arising from the relationship, and that the recipient is getting proper remuneration for their work as an employee.