Family business investment
Written by Ray Coman
Not all taxpayers will have their own business to bequeath, and may therefore acquire a business interest in order to benefit from Business Property Relief (BPR.) An unquoted company, or unincorporated business, which includes AIM listed shares, would benefit from BPR provided the share has been held for two years before it is transferred, either as a lifetime gift or under the directions of a will.
Purchase share from business owner
Where a share in an AIM company is purchased from an unknown vendor, the capital gains tax liability of the seller is not likely to be of concern to the purchaser. However, a liability to capital gains would be a concern where it results from a transaction intended to alleviate inheritance tax. However, a business owner would have incurred a capital gain on receiving monies for a share in the business, regardless of whether that share is later given back to him or her. A simple share transfer would nevertheless be suitable for gifts below the annual exemption for capital gains tax. Where the spouse of the business owner is also a shareholder a further annual exemption could be utilised, and any brought forward capital losses would further dispel liability to capital gains tax.
Subscribe for new shares
In a different scenario, a donor may wish to make their gift directly to the company or partnership, for instance to exercise more control over the employment of this gift. However, if new shares are issued in return for the cash, then this capital would be ring-fenced in a share account, in accordance with company laws which are designed to protect shareholders. Therefore for the minimum two years period for which the donor is a shareholder, the invested capital would not be accessible to the business.
Furthermore, once the shares have been gifted to the business owner, the beneficiaries would have to reduce the share capital, so as to release the cash gift in the company. The purchase by a company of its own shares could give rise to capital gains tax. The capital gain is on the proceeds less the nominal value of the shares. Provided the nominal value of the share is the same as cash contribution, there would be no gain on the amount of the gift. Unfortunately, it will only be possible to treat the disposal of shares back to the company as a capital gain provided various conditions are met. In particular the vendor must have owned the shares for at least 5 years, and the vendor must have an interest in the company which is 75% lower than before the sale. Typically if there is more than one shareholder, then the outgoing shareholder will be retiring, or if there is only one shareholder in the company, the company would probably have to be dissolved.
Using a share buyback, it is a possibility that the gift will not be subject to inheritance tax after two years and that the gift will not be subject to capital gains tax where the company is dissolved after a further five year period. The conditions for business property relief would not be met if at the business had been dissolved at the date that donor had died. However, the gift would at that stage be nearly free of inheritance tax under the seven year rule.
If the business property is transferred under the directions of a Will, the deceased would not be subject to capital gains tax on any increase in share value between the date of joining the company and the date of death. This is because death creates a capital gains tax free uplift in value for assets. While this situation carries the impractical requirement for the donor to remain a shareholder for life with the gift 'locked' in the share capital account, it is nonetheless highly tax efficient and may be considered as an alternative to a trust arrangement. If shares are inherited the length of ownership before they can be bought back by the company, as capital, could be reduced to three years.
For a partnership, there is no requirement to buy back capital, however the introduction of cash would increase the value for the business. A taxable gain would occur if there is a partnership revaluation at the time of the change in partnership sharing ratio. Therefore, consideration should be afforded to any revaluations which occur as a result of capital introduced to the partnership by the donor, after the donor has joined the business.
The allocation of new shares in the company for a nominal value would avoid the restriction on share capital caused treating the capital introduced as a share purchase. A possible method for avoiding capital gains tax would be to treat the initial capital contribution as a shareholder loan. The main pitfall with a loan arrangement is that the eventual write off of a loan may be a non-trading credit in the accounts and therefore subject to corporation tax. A loan agreement may be suitable where profits can be offset, for instance, via the purchase of equipment or pension contributions to the directors.
Another method to avoid the imposition of company and tax law on the arrangement, is for the investment in the company to be treated as a gift, and recognised in the accounts under an account for donation reserve. The potentially exempt transfer would not in itself be eligible for business property relief. However tax relief may be available if part of an arrangement to involve the donor in the company, such as those discussed above.
Without the protection afforded from the capital being regarded as a share subscription, the benefactor may seek some alternative assurance that the funds are utilised in the business interest. Care should be taken in the framing of any such agreement, since if the capital introduced requires a manner of reciprocation; it may not be in the nature of a gift and therefore subject to corporation tax.
There are a number of options for a person wishing to mitigate inheritance tax by contributing capital to a company owned by a beneficiary. However there are a number of pitfalls, some of which have been explored in this briefing.
It is not possible to explore all permutations within the scope of this article and the most suitable course of action will depend on the circumstances of each case, the objectives and priorities of the people involved. At Coman & Co, our focus is on delivering advice which considers the impact of all areas of taxation and the most practical solution in each case. Please email your query.