When it comes to savings and investments for children it’s good practice to start them young. Giving them a stake in the family company is one option that, in the long term, comes with tax benefits. How can you take advantage of them?
Shifting income to your kids
For almost as long as income tax has existed parents have tried ways to mitigate their tax bills by diverting income to their minor children. These schemes have almost invariably failed because of HMRC’s wide-ranging anti-avoidance rules known as the settlements legislation. The effect is that parents remain liable to tax on income derived from assets (unless the income per child is less than £100 per year), e.g. cash, stocks, shares etc. which they’ve transferred to their children.
Diverting profits
While the anti-avoidance rules prevent you from shifting the tax bill on dividends by transferring shares to your children, there might still be tax advantages to it. The first point to note is that while you’ll pay tax on your children’s dividends this doesn’t increase your tax bill as you would have had to pay tax on them anyway. What’s more, giving away shares now can save you tax later.
Tip. On reaching 18 (or marrying at 16 or 17) the settlements legislation ceases to apply. That means you’ll no longer be liable to pay the tax on dividends paid to your children.
Example. Phil is a higher rate taxpayer. His fledgling company issues a small number of shares to his two children (aged 5 and 8), say 5% of the company’s ordinary share capital each. The dividends paid on these are taxable on Phil. When each of his children reaches 18 they become taxable on the income. Both children go into further education. They can use the dividends they receive from the company to help fund them through university. If they didn’t have this Phil would have to fund them from his taxed income. Assuming the children have no other income, the tax saving would be significant.
| If received by Phil | If received by children | |
|---|---|---|
| Dividends | £18,000 | £18,000 |
| Taxable at 33.75% | £18,000 | |
| Less tax-free personal allowances, say | £25,000 | |
| Taxable | Nil | |
| Tax Payable | £6,075 | Nil |
Because of early tax planning Phil has provided a source of tax-free money for his children for when they reach 18.
Tip. To make the planning flexible, Phil’s company could issue alphabet shares to the children, e.g. a different class of ordinary shares from those owned by him. This would allow the company to pay dividends at different rates to each shareholder.
Capital gains tax saving
If Phil were to sell or wind up his company, part of the proceeds would be payable to his children as shareholders. Any resulting capital gain would be taxable on them even if the sale/winding up occurred when they were minors. The children are each entitled to an annual exemption to reduce their capital gains tax bills.
This article has been reproduced by kind permission of Indicator – FL Memo Ltd. For details of their tax-saving products please visit www.indicator-flm.co.uk or call 01233 653500.