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A common question: Can I use my minor children’s personal allowance and transfer some income to them?
One of the questions I am often asked is whether I can put money or assets in my children’s names to save taxes.
A common version of this is: “Can I use my minor children’s personal allowance and transfer some of my income to them?”
It is true that each child has his or her own personal allowance, but when the child is under 18, it is not so simple.
A related question I get from parents with small family businesses is whether they can give their children shares in the business.
Again, this is not so simple: there is a lot of legislation, some fiscal and some legal, that can really confuse the unwary.
Let’s take a look at the rules and do’s and don’ts in this area to give parents a better idea of where they stand.
What is HMRC’s position on putting assets in your children’s names to save tax?
From HMRC’s point of view, everything is set out in the Income Tax (Trade and Other Income) Act 2005.
If the parent retains an interest in an asset and it can still be used for the benefit of the parent or their spouse (for example, by diverting income earned from an asset from them to their minor children), then HMRC would deal with this under what is known as winding-up legislation.
Without getting into too many technicalities, an agreement can:
– Means any agreement, arrangement or transfer of assets; and
– There must be a ‘generous arrangement’
So what does “abundant” mean in this context? This is key to understanding the situation.
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Suppose a parent transferred income to a child, who would have a lower tax liability than the parent.
In this case there would be a “payoff,” because the father would in effect retain an interest in the income-producing asset: the income would no doubt pass to the household as it did before the agreement was made.
Such a transfer would be easily challenged by HMRC and in these circumstances the income would still be taxable to the parent (known as the “settlor” in legal jargon).
This does not only apply to arrangements with minor children. It can also apply to transfers of assets to other family members or friends, in which case the settlor may benefit from such an arrangement.
The test is whether or not it is an “arm’s length transaction.”
Would you make the same payments to a person you have no relationship with? If you didn’t, it would probably be considered a “generous” arrangement and would be subject to legislation.
There are some important exceptions worth noting, which would not conflict with the law, and they are as follows:
– A direct gift between spouses or civil partners without restrictions, retained interest or conditions attached to the asset;
– A benefit under a relevant pension scheme;
– Income from agreements entered into by one party with another following a divorce or separation agreement;
– Commercial transactions.
What if it can be argued that there is no generous agreement?
If the transaction between a parent and a minor child does not fall within the rules I have already explained, then it will fall within section 629 of the same legislation I mentioned above.
Basically, this says that income arising from an arrangement is still treated as income of the grantor if it is paid to or for the benefit of a relevant child of the grantor.
A relevant child is a son or stepchild who is not married or in a civil union.
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This means that if a father gives shares to a son without any retained interest and without any obviously generous arrangement, but purely for the benefit of the son, then the income, if it exceeds £100 per year, will be taxed by the father.
Each parent has an allowance of £100, so the income generated by the money donated by both parents would allow the child to earn £200 per year.
If more is paid, the income will be taxed by the parents.
This may include income from the bank account if the parent or parents give money to the child.
The same rules apply to trusts where the father is the settlor.
If you create a trust to benefit your minor children, you will be taxed on any income arising from it, or in the case of discretionary trusts, on any payments made for the benefit of the child, until the child turns 18.
The rule does not apply to grandparents, for example, so grandparents can gift money for the benefit of a child without such restrictions.
So what are your options if you want to transfer assets to a child?
If a gift is made outright without any retained interest, then a grandparent or other person other than a parent may make a trust arrangement, gift money to a child for his or her benefit, or gift other assets.
It should be made clear that it is the grandfather, or another person, who makes the settlement himself and not through a parent.
Care must be taken, as indirect gifts may be covered by legislation.
For example, suppose the father gifts an asset to the grandfather and several years later the grandfather gifts the asset to the son.
In that case, any income arising from that asset could be taxed by the father, even if he would not retain any interest in it, since he could be considered the settlor.
Obviously, gifts of assets may attract other taxes, such as capital gains tax, or be treated as gifts for inheritance tax purposes, or attract inheritance tax as a taxable lifetime transfer if made into a trust.
Once children reach the age of 18, gifts can be made as long as the parent retains no interest in the asset or its income.
In assets jointly owned by a parent and child, the child should have complete freedom with respect to his share of income to spend as he wishes and be equally responsible for his share of the maintenance of the asset.
What if you want to involve children in your private company?
If you wish to give shares to minor children, all the rules explained above apply.
If you want to involve them in a business, for example by creating a family investment company, you should seek professional advice because things quickly get complicated.
In a private company, unless prohibited by the articles of association (the written rules for the running of the company by its directors and shareholders), shares can, in theory, be held by a minor.
But shares can usually have rights that are not linked to the child’s shares (for example, voting rights).
And a child owning shares could cause problems due to the fact that he or she is a minor and therefore cannot enter into a contract, except where the contract relates to what are known as “necessary things” – housing, food, clothing, or education, apprenticeships and employment.
A child cannot be a director of a limited company until he or she turns 16.
What else do you need to know?
In public companies, children would normally not be able to own shares until they are 18, but these can be held in trust on their behalf, if they are inherited, for example.
A child cannot legally own residential or commercial property. Any property owned by the child will most likely be held in trust until the child turns 18.
A child can have a bank account that can pay interest and of course a Junior ISA can be opened where the money is locked in and they gain control of it at age 18.
Ask Heather Rogers a tax question
Tax expert Heather Rogers answers our readers’ questions
Heather Rogers, founder and owner of Aston Accountancy, is our tax columnist. She is ready to answer your questions on any tax topic: tax codes, inheritance taxes, income taxes, capital gains taxes and much more.
If you would like to ask Heather a question about tax, please email her at taxquestions@thisismoney.co.uk.
Heather will do her best to respond to your message in an upcoming monthly column, but will not be able to respond to all or communicate privately with readers. Nothing in her responses constitutes regulated financial advice. Posted questions are sometimes edited for brevity or other reasons.
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If Heather can’t answer your question, you can Learn how to get tax help here. including sources of free professional advice if you are older and/or on low income.
You can also contact us Money Helpera government-backed organisation that provides free financial assistance to the public. Its number is 0800 011 3797.
Heather offers tips here on finding a good accountant, including when to seek help, hiring the right type of firm, and typical costs.
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