Can gifting shares to your family members help you save tax?

Husband and wife working together

If you would like to gift shares to your spouse or a family member, have a read of this article first.

As accountants for small businesses in London, we are often asked if it makes sense to gift shares of your company to a spouse or a family member. As there is no legislation in place to address this issue specifically, plus there is a risk that HMRC can (and do) challenge the approach you take, the answer depends on your situations. We would encourage you to seek independent and professional advice before taking any action.

In this article, let us take a look at a common driver behind shares gifting and use examples to help explain the tax implication.

Why do you want to gift shares?

The main reason small business owners want to gift shares to their spouse or a family member is to minimise the overall tax obligation within the family by utilising dividends paid to the spouse or family member. The recipient is usually someone who is in a lower tax bracket and can therefore take advantage of personal allowance and basic rate band.

To kick start the discussion, let’s take a moment to explain what dividends are. Essentially, when a company makes a profit after tax, it retains part of the profits and distributes the rest to its shareholders as dividends. How much each shareholder will get depends on the number of shares held.

If you own 100% of the business and you declare a dividend of £30k, you will get the full £30k because there are no other shareholders.

If you gift 30% of your shares to a spouse and retain 70%, when you declare a dividend of £30k,

  • You receive £21,000 (70% of the £30k)
  • Your spouse receives £9,000 (30% of the £30k)

By receiving a lower dividend, you lower your tax bill accordingly. On the other hand, if your spouse does not have an income, they do not have to pay tax on the £9,000 dividend mentioned in this example because the amount is less than £12,500, the income one is allowed to receive before having to pay income tax, aka personal allowance in tax year 2019/20.

The advantages of dividends

Dividends are well used by small business owners because of their three main benefits:

  • The first £2,000 of dividends are not taxable
  • Unlike salary, dividends are not subject to National Insurance
  • Dividends have a lower tax rate than salaries

For tax year 2019/20, dividend tax rates are:

  • 5% (up to £37,500)
  • 5% (£37,501 – £150,000)
  • 1% (over £150,000)

To help illustrate the relationship between dividends and salaries, and how gifting shares may help one to be more tax-efficient, let us use a few simplified examples below to show you.

Example 1: You get a salary of £60k and no dividend

Assuming you own 100% of the shares of your company. You are also an employee receiving a salary of £60k a year and you do not get any dividend.

  • As your salary is £60k a year, your tax-free allowance is £12,500 (for tax year 2019/20). This means your taxable income is £60,000 – £12,500 = 47,500.
  • Out of £47,500, you will pay 20% tax on the first £37,500 and 40% on £10,000. This means your tax obligation is £11,500.
  • You also have to pay National Insurance (about £5,164).
  • Consequently, your take-home pay is approximately £43,336 a year.

Example 2: You get a salary of £10k and receive a dividend of £50k

Assuming you own 100% of the shares of your company and you are also an employee receiving a salary of £10k a year. To make up your income, you declare a dividend of £50k a year. In this example, you do not pay tax on your salary and you also pay less tax on dividends (because they are taxed at a lower rate than salary). Your take-home pay is approximately £53,923 a year.

By comparing your take-home pay in this example which is £53,923 versus the last example £43,336, you can see that your take-home pay increases by £10,587 a year if you take a low salary and use dividends to make up your income.

Example 3: You get a salary of £10k and receive a dividend of £35k and your spouse receive a dividend of £15k

Assuming you gift 30% of your shares to your spouse and you retain 70%. Your salary is still £10k. At the end of the year, the company declares a dividend of £50k to its shareholders:

  • You receive £35,000 (70% of the £50k dividends)
  • Your spouse receives £15,000 (30% of the £50k dividends)

Because you receive less dividends than in the previous examples, your tax obligation is reduced accordingly. In this case, your take-home pay is about £42,548.

As for your spouse, assuming they don’t earn a salary, the income of £15k from the dividends will see them pay just £37.50 in tax and receive a take-home pay of £14,962.50. This pushes the combined take-home pay of you and your spouse to £57,510.50, significantly more than the take-home pay in the previous two examples.

If you are wondering how the £37.50 tax bill which your spouse will pay is calculated, here are the steps:

  • Your spouse receives a dividend of £15,000 and out of which, the first £2,000 is not taxed, meaning the taxable amount is £13,000.
  • Your spouse has a personal allowance of £12,500, this means effectively, the taxable amount is just £50.
  • Dividend has a lower tax rate and in this case, it is 7.5%, so 7.5% of £50 is £37.50.
  • Your spouse also does not have to pay National Insurance.

Disclaimers

The above examples are simplified for discussion only. It must be said that from time to time, the UK government adjusts the amounts of personal allowance and other taxes. How much you will end up paying also depends on your circumstances (like if you have pensions, student loan, so on and so forth).

Dividends enjoy a lower tax rate because they are after tax profits, meaning your company has already paid company tax on the revenues.

Talk to a small business accountant first

Before gifting shares to your spouse or a family member, talk to an independent small business accountant first. The reason is because HMRC does challenge couples who use this approach to lower their tax obligations.

One of the most famous cases was Jones versus Garnett (aka the Arctic Systems case) which happened more than a decade ago. In that particular case, HMRC challenged a couple when the husband allowed his wife to share a percentage of the company’s profit through the use of dividends. When the case reached the House of Lords, it was concluded that the dividends received by the wife fell within the spousal gift exemption. Although HMRC did not win this case, they did win in other similar but not identical cases involving income splitting arrangements between couples.

At Berley, our small business accountants help companies and shareholders to lower their tax bills legitimately. We do not believe in creative accounting that will get you into troubles with HMRC. Our chartered accountants are on hand to discuss your situations and see if the approach of shares gifting to a spouse or a family member is suitable for you. Get in touch with us today by calling 020 7636 9094 today.

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This post is intended to provide information of general interest about current business/ accounting issues. It should not replace professional advice tailored to your specific circumstances.