‘Freezing’ The Family Company! Making Gifts Without Tax Costs

James Bailey looks at a way of passing on the value of an investment company to the next generation without incurring tax charges.

Gifting shares in a trading company to the next generation is comparatively simple. For capital gains tax purposes, you can make a claim to ’hold over’ any gain that arises on the gift of the shares (which is deemed to take place at market value), and for the purposes of inheritance tax, the value of the shares should be covered by business property relief.

If your company is an investment company, however, or a property letting company, things are not so simple, and more sophisticated planning is needed to pass on the shares without creating a tax charge.

What is ‘freezing’?

One technique is known as ‘freezing’. This refers to a process whereby the value of your shares is ‘frozen’ so that it cannot grow any more, and a new class of shares is created that will benefit from future growth.

The ‘frozen’ shares gradually decline in value, and the other shares gradually increase, but for the purposes of both CGT and inheritance tax, this does not result in any deemed gifts.

Example - Gifting shares to the children

Mr Iceman owns all the shares in Famco Ltd, a company that invests in both property and in the stock market. He wants to pass on the company to his adult children but he knows that if he simply gives them shares, he will have to pay CGT on the deemed gain, and if he dies within seven years of the gift, the value of the shares given will be included in his estate – as will the value of any shares he still owns.

The company is valued at £800,000. Mr Iceman is 47, and plans to retire at 60. He typically takes £60,000 a year in dividends from the company, but he looks forward to a decent pension and reckons he will not need these dividends after he retires.

Mr Iceman arranges for the company to issue him a new class of shares (‘B shares’), and to rename his existing shares ‘A Shares’. Famco’s articles of association are amended to say that the B shares are not entitled to anything (whether dividends or a share of the sale proceeds if the company is sold or liquidated) until the holders of the A shares have received £800,000 (again, in dividends or in a share of sale proceeds). The A shares are entitled to £800,000 and no more. Mr Iceman then gives the B shares to his children.

There is no holdover for CGT, but what is the value of the B shares? Given that the B shares are unlikely to be entitled to anything for at least thirteen years if Mr Iceman carries on his present dividend policy, I would submit they are worth virtually nothing.

As time goes by and Mr Iceman receives his £60,000 dividends each year, the value of his A shares decreases, and the value of the B shares increases. After ten years, when Mr Iceman has had £600,000 of the £800,000 that his A shares allow him to have, the value of the B shares will have started to increase significantly, but none of this increase is as a result of a gift by Mr Iceman – it is just a natural consequence of the way the company’s share capital works.

Mr Iceman has succeeded in transferring most of the value of his company to his children at no tax cost, whilst retaining the right to sufficient dividends to see him through to his pension!

Practical Tip:

This is a very simplified description of some sophisticated tax planning, and should not be attempted without specialist advice from both a tax consultant and from a professional valuer.