Dividends for University Students – Be Careful!

Dividends for University Students – Be Careful!
If your son or daughter at university has recently been joining the riots on the streets of London, you may be looking for a method of calming down the fretful child’s protests. For those who own their own businesses through companies which they control, one possibility is to issue shares in the company to the student so that he or she can receive some dividends to help out with university costs. Whilst this sounds very simple, and it can be done effectively, there are some pitfalls.

Ideally you would want to issue ‘B’ non-voting shares in the company carrying rights to dividends and not much else. Shares with such minimal rights would not have any particular value on their own, since they could not be sold, and yet you could declare dividends on them, paid to the student to help finance his or her way through university. As the student will be over the age of 18, you might expect that there will be no tax problems.

The Drawbacks

Unfortunately, HMRC has different ideas. There are rules in the tax legislation designed to prevent people securing tax advantages through ‘settlements’, and rather confusingly these have very wide application and are not just confined to trusts. It would be better to describe the legislation as ‘income tax anti-avoidance via gifts’.

What the legislation says is that if you make a gift of an asset to a third party but retain any continuing interest in that asset or in the income from it, the gift will not be effective for income tax purposes and you will continue to be taxed on that income.

It is the view of HMRC that, as controlling shareholder, you will be able to govern dividends which are paid on the ‘B’ shares and therefore effectively you retain an interest in those dividends. You may say that the same point could be made in relation to any shares in a family company where there is a controlling shareholder/director and in any event, once a dividend is paid on the ‘B’ shares it belongs completely to the student and you cannot have any benefit from it.

Although these may seem to be good points, HMRC says that the whole arrangement must be looked at and they have made it clear that it would not consider ‘B’ share schemes of this type to be tax effective.

The Good News!

This does not mean that the whole idea is dead in the water, but you will need to revise your plans if this is how you want to stop your son swinging from the Cenotaph in the midst of a student riot. You could issue some further ordinary shares in the company as a bonus issue to existing shares, and then give away a small holding of ordinary shares to the student so that he or she becomes a small minority shareholder.

The idea of the bonus issue is to ensure that there are sufficient shares in existence so that after the gift you remain in full control of the company. Of course if you already have, say, 100 shares in issue, you may not need to declare the bonus.

But you will need to construct the arithmetic so that a sensible level of dividends will become available for the student’s ordinary shares. You will also of course need sufficient distributable profits in the company.
The arithmetic can be fine tuned a little if you complete a dividend waiver in advance of an anticipated dividend payment so that only the student receives a distribution from the company.

But if your dividend waiver enables the student to receive a larger sum than would otherwise be the case, once again HMRC will claim that the ‘settlements’ legislation applies to eliminate the tax advantage gained.

You might want to avoid the need for dividend waivers by having an issue of ‘B’ shares to the student, but making sure that the ‘B’ shares have more extensive rights. However it is doubtful whether HMRC would see this as a realistic distinction from the arrangements which they have said are not tax effective.

Practical Tip

Remember that a gift of shares in a profitable company has capital gains tax consequences. In general however, so long as you have not made previous gifts of the shares, a small minority interest in a company is valued at a very substantial discount for capital gains tax purposes. As a result, the gain might well be within your annual capital gains tax exemption, or if it is a trading company the gain can be held over on the gift.

Once the student is a shareholder in the family company, perhaps he or she will not see the need to go rioting again.

By Malcolm Gunn