IHT and the family company

When it comes to transactions between shareholders and family or owner-managed companies, the IHT implications will not normally be a main tax consideration, and might be overlooked completely.

The availability of reliefs, exemptions and the nil rate band may be such that IHT is not a major concern in some cases. However, it would be dangerous to ignore the IHT consequences of transfers involving family-owned companies.

Close companies and shareholders

The IHT legislation deals specifically with close companies (IHTA 1984, ss 94-102, 202). A ‘close company’ is defined as for corporation tax acts purposes (so in practice will cover the normal family type of company, and many owner-managed companies), and ‘participator’ takes its meaning from CTA 2010, s 454 (but excluding anyone who is only a participator due to being a loan creditor), including where the company would be close if it was resident in the UK (IHTA 1984, s 102(1)).

If a close company makes a transfer of value, the amount transferred is apportioned among the participators (ie broadly the shareholders). They are then charged on the grossed-up equivalent of such amount according to their rights and interests in the company.

The deemed transfer is reduced by the amount by which the value of the estate of the participator is increased by the company’s transfer (IHTA 1984, s 94(1)). However, for this purpose we must exclude any rights or interests in the company (for example, allotment of shares in the company). Having regard to this permitted reduction, the section operates only rarely. It is largely restricted to extending the meaning of ‘transfer’ in IHTA 1984, s 98. Thus, a transfer can include:

● any alteration or extinguishment of unquoted company shares or loan capital (for example, the variation of rights attaching to shares so that the estate owner’s equity is watered down); or

● the redemption of debentures, thereby increasing the equity capital; or

● an issue of new shares (for example, to an outsider, especially if at a favourable price).

HMRC guidance on alterations in share capital, etc (in the Inheritance Tax manual at IHTM14855) includes two examples, the first involving two new classes of shares being created and issued to one of the company’s three existing shareholders, and the second illustrating the issue of shares to two new shareholders which vary the proportions in which the company’s share capital are held.

Possible exceptions

Depending on the circumstances, however, it might be possible to argue on the basis of IHTA 1984, s 10 that the transfer was not intended to confer gratuitous benefit but was part of the commercial arrangements to secure the transferee’s services.

There will be no liability under IHTA 1984, s 94(1) to the extent that the transferee suffers income tax or corporation tax (eg as an income distribution by the company); or where a participator is domiciled abroad in respect of foreign assets (IHTA 1984, s 94(2)).

Transfers of value can be traced through another close company, but there is protection against a double charge where a participator holds shares in both companies (IHTA 1984, s 95).

Whose IHT liability?

A liability under IHTA 1984, s 94 is primarily that of the company. The purchasers of shares of such a company should obtain an appropriate warranty from the vendors. Secondarily liable are the participators themselves, the value becoming part of their cumulative total grossed up.

There is an exception to this last rule that applies to a person to whom not more than 5% of the value transferred is apportioned. In that case, the company remains solely liable (IHTA 1984, s 202(2); see IHTM30124). The value is not part of such person’s cumulative total (IHTA 1984, s 94(4)). The charge is also adapted in respect of trustee participators (IHTA 1984, s 99(2)).

No part of the transfer of value is apportioned to preference shares if the transfer of value ‘has only a small effect on the value’ of those shares compared with its effect on the value of other parts of the company’s share capital. As a result, they are normally left out of account in determining a participator’s rights and interests (IHTA 1984, s 96).

Where a close company surrenders losses by way of group relief (under CTA 2010, s 99), such a transaction does not give rise to any charge to IHT (IHTA 1984, s 94(3)). Certain actual or deemed transfers within a group of companies (under TCGA 1992, s 171 or s 171A) are ignored for the purpose of apportionment among minority participators in some cases (IHTA 1984, s 97).

Charges under IHTA 1984, s 94 benefit (by virtue of IHTA 1984, s 94(5)) from the £3,000 annual exemption. A decrease in value resulting from an alteration of share etc rights under IHTA 1984, s 98(1) is ignored for the purpose of assessing a person’s estate on death in view of IHTA 1984, s 171(2).

It is made clear that, bearing in mind the consequential loss formula of IHTA 1984, s 3(1), alteration of share etc rights only reduces the value after the disposition, not before. If it applied both before and after there would be no chargeable fall in value. In the case of a wholly-owned subsidiary of a close company which makes a transfer of an asset at an undervalue to its parent or to a wholly owned sister subsidiary, or in the case of a dividend paid by such subsidiary to its parent company, HMRC do not regard it as a transfer of value, so that IHTA 1984, s 94 does not operate. The position is less clear where the parent-subsidiary relationship is not one of 100% ownership.

When a close company makes a transfer of value, IHT is charged as if each participator has made a transfer (IHTA 1984, s 94(1)). The transfers attributed to the participators cannot, therefore, be treated as PETs (IHTA 1984, s 3A(6)). They constitute immediate lifetime chargeable transfers of the grossed-up amounts. IHT is charged as if each individual participator had made a transfer of value of the amount apportioned to them by reference to their rights and interests in the company immediately before the transfer (IHTM14852).

The above is based on an extract from Ray and McLaughlin’s Practical Inheritance Tax Planning (16th Edition). For more information about this title, visit our website.

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