One of your clients has recently married. He is looking to pass some shares to his new spouse to enable them to save income tax. He was planning to gift them now that the transfer would be exempt from CGT, but is there a hidden opportunity here?
Income splitting
Your client owning a company jointly with a spouse, rather than on their own, is basic planning where one of them pays tax at a higher rate than the other (or one pays no tax at all). The idea is that by both owning shares they can each use their tax-free allowances, dividend nil rate band and other rate bands to minimise tax on dividends the company pays.
Newly-wed
As your client has only recently married his partner, he may have held off transferring shares until after the wedding. This may have been for security, i.e. in case the relationship ended, but would also have ensured the gift didn’t trigger a capital gains tax bill by virtue of the inter-spouse exemption. The transfer can be made now in order to achieve the tax savings. But is a gift the best way to proceed?
Consider selling
If your client is a homeowner with a mortgage, it might be better for them to sell the shares to the spouse instead. In this way, it can be possible to attract relief on some of the mortgage interest with careful structuring. The following example illustrates how this can work.
Example. Barney started Acom Ltd ten years ago. It’s done well and is now valued at £600,000. Acom pays Barney £100,000 per year in dividends on which nearly £50,000 is taxed at the higher rate. His wife Betty has only modest income. To make use of her tax-free allowances and basic rate band to reduce the tax bill on the dividends, Barney’s accountant advises him to give half of his shares to Betty.
Barney and Betty have a £200,000 mortgage on which they pay £11,000 interest per year. There’s no tax relief on loans used to buy a home but there is for loans to buy shares in a close company. This gives an opportunity to save some tax.
Further information, including the conditions, can be found in HMRC’s Savings and Investment Manual (see Follow up ).
Pro advice. If Barney sells the shares to Betty instead of gifting them, any money she borrows to fund the purchase will qualify for the tax relief.
Barney sells half his shares to Betty at a discounted price of, say, £100,000. Betty takes a loan on similar terms to the mortgage (this could even be a mortgage extension) to pay Barney. He then uses the money to repay £100,000 of the mortgage. As a couple, their overall borrowings are the same as before.
Pro advice. Even though the shares are sold, the inter-spouse exemption still applies, so no CGT bill is triggered.
Additional relief
The effect of the arrangement is that between them Barney and Betty have swapped £100,000 of their home mortgage for £100,000 to purchase shares in Acom Ltd. Because interest on the latter is a qualifying loan, the interest paid on it, around £5,500 per year, now qualifies for tax relief. This will reduce their tax bill by £1,100, i.e. £5,500 x 20%.
If your client has a mortgage, it could be more beneficial for their new spouse to borrow money to purchase the shares. Your client could use the funds to pay down the mortgage, i.e. so as a couple they have no additional borrowings, and the spouse will be able to claim tax relief on the interest on the qualifying loan.