Protection

Gifting trading company shares to a Trust enables you to pass capital value and income out of your Estate whilst still protecting the shares for the family members listed as beneficiaries of the Trust. As assets and income of a Discretionary Trust are not owned by the beneficiaries and are only paid out at the discretion of the Trustees they are therefore protected from the following:

• creditors should a beneficiary fall into financial difficulty
• from being lost to the family in the event of a divorce of a beneficiary
• from being wasted on depreciating assets and unsuitable investments.

A Trust will also enable a shareholder to give away the capital value of shares but still retain some voting control over those assets in their role as Trustee of the Trust.

As a Trust can last for a maximum of 125 years the assets can be protected for multiple generations and therefore a Trust provides flexibility for those who do not wish to give away shares directly to their potential beneficiaries either in their lifetime or via their Will.

Inheritance Tax mitigation

Whilst trading company shares can typically be passed down between individuals without triggering an immediate Capital Gains Tax or Inheritance Tax charge, this might not always be suitable due to the protection issues discussed above. An alternative, would therefore be to consider a Discretionary Trust.

Unquoted trading company shares generally qualify for Business Property Relief for Inheritance Tax, but there is no guarantee that this will continue to be the case, particularly in the event of a change of Government. You may therefore wish to gift these shares into a Discretionary Trust whilst they do qualify for the relief.

In addition, if there is a prospect that the trading company might be sold in the future it would be worth considering a transfer of some shares into Trust now whilst the shares qualify for Business Property Relief. This can enable a percentage of value to be removed from your Estate earlier than it otherwise would be if proceeds of a sale were gifted, and unlike gifting sale proceeds, a gift of qualifying shares will not be limited to an individual’s nil rate band of £325,000 (after which a lifetime tax charge of 20% arises on the value of a gift of cash and certain other assets into Trust).

Whilst the Trustees would pay Capital Gains Tax at 20% on a subsequent sale of these shares this is the same rate as an individual would pay on proceeds above £1m since the Business Asset Disposal Relief lifetime limit was reduced to this amount. Such a gift would still be subject to 7-year survivorship to ultimately be effective for Inheritance Tax, as would a post-sale of cash proceeds, but under the Trust route the time clock for this purpose is able to start much sooner, often many years in advance.

Example

Let’s say that a trading company has a market value of £10m, the husband-and-wife shareholders decide to gift 25% of the shares to a Discretionary Trust for the benefit of their adult children and grandchildren. As the shares qualify for Business Property Relief there is no Inheritance Tax charge on the gift to the Trust. A Capital Gains Tax charge is likely to arise, but this can be deferred by using a holdover relief claim. If the business is subsequently sold then the Trust will receive £2.5m of the proceeds which is outside of the individual shareholders Estate for Inheritance Tax, this is almost £2m more than they would have been able to shelter from Inheritance Tax if they instead had retained all of the shares until a sale and then gifted cash equivalent to their nil rate bands (£325k each) out of their sale proceeds.

Trusts can be used in a similar way if due to the company’s retained funds, or future plans, make it likely that it will loss its trading status in the future. Place the shares into Trust before that change can bank the Business Property Relief now and result in a larger value being moved from your Estate into Trust that would be possible once the status of the company changes.

Funding school and university fees for Grandchildren

Trusts can provide a very tax efficient means of paying for school and university fees and dividends paid from a trading company can be an ideal way of funding these costs. All individuals (including minors) receive a personal income tax allowance and dividends received by a Trust that are subsequently paid out for a beneficiary will ultimately be taxable on that beneficiary.

This can be very useful where Grandparents own a trading company and wish to contribute towards Grandchildren’s school and university fees, some shares can be gifted into Trust and then dividends voted on those shares to cover the required fees. As it is likely that the Grandchildren will have no other income the dividends may be covered by their personal allowances in full or be subject to basic rate dividend tax of 8.75%, much more efficient than if the Grandparents had paid the fees from their own taxed income which could have suffered tax at a rate closer to 40%.

Care should be taken to ensure that the Trust/Trustees contract with the school to pay the fees, rather than reimbursing the parents.

This strategy is not appropriate for parents looking to cover fees for minor children as in this case the dividend income is reassessed and taxed on the parent and therefore this is mainly aimed at Grandparents who own trading businesses.