Giving away shares in a family company - income tax trap
Tax and gifts of shares
Usually, the discussion when a shareholder transfers shares in their company revolves around capital gains tax and whether or not it can be deferred using gift relief. However, where the transferor borrowed money to acquire the shares, there might also be a loss of income tax relief to consider.
Qualifying loan
If you borrow money to purchase ordinary shares or provide capital to a company for the purpose of its trade, you can claim tax relief on the interest you pay on the loan. Naturally, there are conditions to the relief, one of which is that if you receive a return of any of the capital invested in the company the tax relief is reduced accordingly.
For detailed commentary on the conditions for tax relief on loan interest, visit https://www.tips-and-advice.co.uk , Download Zone, year 22, issue 9.
Example. In 2015 Andreas borrowed £100,000 from his bank which he used to start Acom Ltd. It issued Andreas with 100 shares in exchange for the cash. Since 2015 Andreas has claimed tax relief for the interest paid on the loan. In 2021 he sold 25% of his shares to an outside investor for £60,000 which he uses to pay for an extension to his home. Regardless of the use to which the proceeds were put it counts as a return of his original capital invested. Andreas is now only entitled to claim tax relief on 40% of the loan interest ((£100,000 - £60,000)/100).
Trap. A reduction in the amount of interest qualifying for tax relief can apply even where no payment is received in connection with a share sale or transfer.
Non-arm’s length transactions
A return of capital is deemed to have occurred in some circumstances where no money is received by the transferring shareholder in exchange for their shares. The legislation says that any transaction, e.g. a gift of shares, which is “not at arm’s length” is treated as if market value had been given (see The next step ). Market value is the amount that a third party who has no connection with you would be willing to pay for your shares if they had all the information about them they could reasonably expect to have.
Example. Harry set up Bcom Ltd using a £60,000 further advance on his home mortgage. Harry claims tax relief he pays on the advance. Bcom issues him with 60 ordinary shares in exchange for the cash. The company performs exceptionally and after just three years is valued at £500,000. On advice from his accountant he gives 25% of his shares to his spouse. As a minority holding their market value is, say, £95,000. This exceeds the amount paid by Harry for the shares in Bcom. Therefore, from the date Harry gave away the shares he’s not entitled to any tax relief on his £60,000 borrowing.
Tip. There’s no legitimate way to avoid the return of capital rule. But being aware of it means you can avoid trouble with HMRC by ensuring that you don’t overclaim tax relief for interest on loans used to fund investment in your company.
For more information about what type of transactions count as not at arm’s length, visit https://www.tips-and-advice.co.uk , Download Zone, year 22, issue 9.
Create your profile to unlock this advice and many more.