It is natural for shareholders of a family company to eventually want their children, who may already be involved in the business, to take over and allow the older generation to step back.
However, there can be unexpected complications due to employment-related securities (ERS) legislation.
An unusual rule
Even though the shares acquired by the children may not actually be connected to their employment, they are still treated as acquired by reason of employment under a peculiar rule.
This rule deems shares to be employment-related, whether they are or not.
Thankfully, there is an important exception to this rule for shares acquired through normal domestic, family, or personal relationships, which applies in this situation.
Where the exception applies, the shares are not subject to the complex and burdensome provisions of Part 7 of the Income Tax (Earnings and Pensions) Act 2003 (ITEPA 2003).
Additionally, if the exception applies, the acquisition is not required to be reported to HMRC, unlike an actual or deemed ERS acquisition.
However, if the company instead issues new shares to the children of the parent shareholders, a different interpretation comes into play.
The exception from the deeming provision only applies if an individual provides the right or opportunity to acquire the shares.
Although the previous HMRC guidance in the Employment Related Securities Manual acknowledged that the exception might still apply when the shares are issued by the company, the current guidance appears to adopt a stricter interpretation.
On the other hand, when an employee acquires shares in their employer’s company for less than their market value, the discount is taxable as earnings under section 62 of ITEPA 2003, rather than as a chargeable event under ERS rules.
However, in the circumstances being discussed, such an acquisition would not typically attract the earnings charge.
Unfortunately, this leads to an anomaly in the calculation of the ‘chargeable proportion,’ which becomes taxable when a chargeable event occurs in relation to restricted securities (which are how most private company shares are categorised, rightly or wrongly).
Since no charge arose upon acquisition, there is a 100% uncharged proportion that becomes taxable when a future chargeable event arises.
For instance, if the children were to sell their shares, the entire proceeds would be taxable as employment income according to the current legislation.
It is unlikely that this consequence was foreseen when the law was drafted, but it should not be overlooked.
How should I deal with this?
A practical suggestion in this situation would be for the company to issue additional shares to the parents, who can then gift them to their children.
By making a holdover election under section 165 of the Taxation of Chargeable Gains Act 1992 (assuming the company is a trading company), this approach may be beneficial.
If shares are directly issued to the children, it is crucial to make an election under section 431 of ITEPA 2003 to pay tax on the market value of the shares, disregarding any restrictions.
This election removes the shares from the restricted securities regime going forward. There are no drawbacks to making this election since no charge arises upon acquisition in these circumstances, but it still might be advisable to do so.
How we can help
At Williamson & Croft, we are well-equipped to assist individuals and families with navigating the complexities of succession planning.
Our experienced team of professionals understand the nuances of ERS legislation and can provide expert guidance on transferring shares to the next generation.
We will work closely with you to assess your unique circumstances, including family dynamics and business structure, to develop tailored strategies that meet your goals.
From understanding the deeming provision and exceptions to providing comprehensive tax advice, we ensure that your succession plan is both legally compliant and tax efficient.
By leveraging our expertise, you can gain peace of mind, knowing that your succession plan is in capable hands, and confidently pass on your business and wealth to the next generation.
Contact us today for further information.