Peter Rayney reviews the key tax issues that affect the structuring of shareholdings in a family company
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Companies are often set up in a hurry with no real thought being given to the commercial and tax efficiency of their shareholding structures.
For various personal reasons, some family company ‘owners’ prefer to hold all the shares. As far as they are concerned, this gives them ‘total control’. In practice, overall control can be enjoyed by holding at least 75% of the voting rights, since this would enable the ‘owner’ to pass special resolutions, vary its constitution and put it into liquidation. For effective day-to-day control, such as the appointment and removal of directors, determination of remuneration and dividend policy, it is only necessary to hold more than 50% of the shares.
Owner-managers may be prepared to share effective ‘control’ with their spouses and family trusts (of which they can be ‘first named’ trustees). This can often be beneficial for many tax reasons, including dividend extraction. Spreading dividend income amongst close family members, where this is practicable, has become even more important given the increases in dividend taxation announced in Autumn Budget 2025. From 2026/27, the dividend basic rate and higher rate increase by 2% to 10.75% and 35.75%, respectively.
If the owner’s adult children or other close family members play an active part in the business, serious consideration should be given to them having some shares. Gifting shares in this way should motivate them and perhaps reward their contribution to the increase in the company’s value created by their efforts. This will also aid the ‘succession planning’ process and, of course, would generally create a positive psychological impact on the family members.
Transferring shares in a trading company by way of gift should normally be a relatively benign event from an inheritance tax (IHT) and capital gains tax (CGT) viewpoint (providing the parties enter into CGT business asset holdover elections under TCGA 1992, s 165).
From an IHT perspective, the ‘new’ IHT business property relief (BPR) restrictions come into play in April 2026. Following the government’s pre-Christmas 2025 announcement, the 100% BPR exemption will be ‘capped’ at £2.5m per shareholder, with any excess amount only being eligible for a 50% BPR reduction. These changes have given increased impetus to accelerating the transfer of shares to family members. The gift would be a potentially exempt transfer (PET). Thus, provided the transferor survives the relevant seven-year ‘window’, there should be no IHT. On the other hand, if the PET fails (i.e., they die within the seven-year survivorship period), the IHT ‘death’ re-calculation (after 5 April 2026) is required to be made using the new restricted BPR rules. Thus, IHT of some 20% (40% IHT rate x 50% BPR) may arise on the failed PET where the value of the shares (at the date of the transfer) exceeds £2.5m (subject to any available nil-rate band or IHT taper reduction).
On the other hand, the transfer of shares to a spouse or civil partner normally has no such restrictions. The transfer is automatically free of IHT (spouse exemption) and is CGT neutral (no gain, no loss transfer).
In most cases, where shares are gifted to close family members, there should be no ‘employment income’ tax charge due to the exemption in ITEPA 2003, s 421B for ‘shares made available in the normal course of domestic, family, or personal relationships’. Given HMRC’s tighter stance on this exemption, it is always recommended that existing shares be gifted (rather than issuing new shares) to the family recipients.
A word of warning – owners should aim to keep the company’s shares tightly held between ‘trusted’ family members and possibly key management team members. All too often, proprietors end up regretting their (or their parents’) decision to issue shares to certain family members (usually to satisfy some emotional obligation). This can be especially problematic when these family members become ‘difficult’ or feel disenfranchised.
Owner’s financial security and likelihood of a future sale
Many family company owners view the business as a way of building up their financial security. When the time comes for them to step down and hand over control, the company should have provided them with sufficient funds for their future requirements. The owner can obtain ‘independent’ financial security by taking sufficient remuneration, dividends, and ensuring appropriate pension provision is made throughout their working life. For many, this equates to maximising the amount of shares held.
If the owner-manager’s main objective is to build up the company for a future sale, they should ensure that they hold sufficient shares to achieve the desired level of future sale proceeds. The vast majority of owners will wish to access the beneficial business asset disposal relief (BADR) CGT rate of 14% (the rate for 2025/26, which increases to 18% from 2026/27) (which is available on the first £1m of gains). Proprietors should ensure they maintain a qualifying shareholding to enable a competent BADR claim to be made when the need arises. Shareholders (who must be officers or employees of the company) will qualify for BADR provided they own at least 5% of the ordinary share capital, carrying at least 5% of the voting rights and at least 5% economic rights throughout the two years before the share sale or cessation of trade.
Owners with substantial equity should take special care where the company has different classes of shares. The definition of ‘ordinary share capital’ is extremely wide and shares with minimal economic rights can sometimes have an adverse dilutive impact on the key shareholders' BADR eligibility (as demonstrated in McQuillan v HMRC [2017] UKUT 34 and Castledine v HMRC [2016] UKFTT 145.
Dividend extraction
Tax considerations are also an important driver, ensuring that shareholders can access key tax reliefs and are able to extract appropriate value through dividend payments. The owner-manager will usually require a substantial holding or perhaps a separate class of shares to satisfy their personal financial needs (through dividends).
It is worth noting that, with the increases in corporation tax, dividend tax and National Insurance contributions rates, bonuses may give a better post-tax outcome than dividends. It now always pays to do the relevant comparative tax calculations when making a decision about the ‘bonus or dividend’ extraction route.
On the other hand, where family members are involved, it is likely that no or little corporation tax relief would be available if they do not actively work in the business. Dividends will almost always be preferred in these situations. The tax mechanisms for gifting shares are discussed above. To ensure flexibility in the level of dividends going forward, the use of different classes of shares is recommended. Owner-managers must be careful to avoid being caught by the ‘settlements’ rules. In the case of spouses or civil partners, this is best done by ensuring that the spouse receives shares containing the full bundle of legal rights (i.e., voting, capital and dividends) – this should ensure the ‘outright gift’ spouse exemption applies (in ITTOIA 2005, s 626).
The payment of dividends to minor children of the owner-manager (settlor) is likely to be caught by the parental settlement rules (in ITTOIA 2005, s 629), so the dividend income would be taxed in the settlor-parent’s hands. There is really nothing that can be done about this (there is no equivalent of the spousal ‘outright gifts’ exemption).
Conversely, dividends paid on shares held by their adult (over 18 years old) children should not be caught by these provisions. Thus, dividends paid to such children can benefit from their personal allowances and lower dividend rate tax bands. Parents who require a greater level of control over income passing to their adult children should consider using a family discretionary trust – but that is a subject for a future article.
Practical tip
Even in the context of a family company, a shareholders' agreement is recommended to ensure there is clarity around the shareholders' rights and obligations to each other, how exits are dealt with, dividend policy, and so on.
