Holdover relief tax trap

Newsletter issue - February 2022

Some small company owners bring in adult children to take over the day to day running of the business as they approach retirement. There are many strategies used in practice. One may be to appoint the children as directors, while maintaining overall control of the share capital. However, some owners may wish to hand over full control and exit the company altogether and gift the shares to the children as well.

This involves a transfer of value, i.e. the value of the shares being gifted. However, thanks to business property relief, this is unlikely to trigger an IHT charge, unless the company is wholly or mainly carrying on investment-type activities (property-related businesses like caravan parks etc can be a grey area here). However, capital gains tax (CGT) can be an issue, as the transfer will be treated as taking place at market value.

In the absence of relief, the owner would be faced with a dry CGT bill. However, holdover relief under s. 165 TCGA 1992 can be jointly claimed by the transferor and transferees. This effectively rolls the gain up into the base cost of the shares in the hands of the recipients, and so it will not be taxed until the shares are disposed of later on. If the children pass on the shares to their own children, the process can be repeated etc.

Anti-avoidance

Gains on shares, even in UK-based companies, are only taxable if the person making the disposal is UK resident at the time of the disposal (subject to certain rules for temporary periods of non-residence). As a result, it would seem relatively simple on paper to make a gift of the shares and have the recipient leave the country before making a disposal of them.

To combat this, there is a restriction on s.165 relief where the transferee becomes non-resident within six years of the end of the tax year they received the shares in. If this occurs, the held over gain becomes taxable, and if the transferee doesn't pay the tax due, HMRC are entitled to recover it from the transferor, i.e. the original shareholder.

Of course, there may be genuine reasons for becoming non-resident, but in most cases the motive won't make a difference to the clawback of relief. The only possible get out is if the non-residence is in order to work overseas for no more than three years. It is advisable to inform HMRC of the intention prior to the relocation to avoid a CGT charge being assessed in the first place.

There is a further provision that applies to a gift of UK land, where an election can be made to defer the gain until disposal of the land, as non-residents are now charged to UK CGT on all UK land disposals.