Is My Accountant Being Aggressive re: Income Splitting Legislation?

[WordIsBond]

(Apologies to OP - not wanting to derail your thread)

No problem, good point, though I've lurked long enough to know what he meant.

[Iliketax]

What did your accountant say about the employment income tax implications of your kids/their spouses acquiring the shares? In particular, what did he or she think about the value of those shares? A share in a private company paying £2,000 dividends per year may be worth, say, £20,000? That's a lot of money to pay employment income tax on.

If your accountant said no employment income tax on acquisition of the B shares because this is a family thing then, from the facts that you have described, that would be just plain wrong.

If your accountant said that the value was low so don't worry about it then google "HMRC alphabet soup". You'll find that HMRC will say that PAYE/NIC is due on the increase in value of the B shares caused by the declaration of a dividend and then dividend income tax on the dividend. So for a higher rate taxpayer that gives a marginal tax/NIC rate of 67% (and up to 83% if the PAYE is not reimbursed in time) plus employer's NIC. So getting the "alphabet soup" position wrong would be very painful.

Many small family companies "do" alphabet soup and their advisers will say that what they do is perfectly legal. But they said that about [insert your favourite perfectly legal plan where APNs have now been received].

In the past, HMRC had difficulty to spotting this sort of thing. But the new online share plan reporting requirements have extra questions that allow HMRC to assess the risk of tax avoidance. One of these is to ask whether the shares are part of the largest class of share in the company.

For the avoidance of doubt, what I am saying on the alphabet share point has nothing to do with the normal salary/dividend choice where there is a single class of share.

The other side of all this is implementing it properly. What protections will there be for you if you fall out with your kids or they divorce?

[WordIsBond]

What did your accountant say about the employment income tax implications of your kids/their spouses acquiring the shares? In particular, what did he or she think about the value of those shares? A share in a private company paying £2,000 dividends per year may be worth, say, £20,000? That's a lot of money to pay employment income tax on.

If your accountant said no employment income tax on acquisition of the B shares because this is a family thing then, from the facts that you have described, that would be just plain wrong.

If your accountant said that the value was low so don't worry about it then google "HMRC alphabet soup". You'll find that HMRC will say that PAYE/NIC is due on the increase in value of the B shares caused by the declaration of a dividend and then dividend income tax on the dividend. So for a higher rate taxpayer that gives a marginal tax/NIC rate of 67% (and up to 83% if the PAYE is not reimbursed in time) plus employer's NIC. So getting the "alphabet soup" position wrong would be very painful.

Many small family companies "do" alphabet soup and their advisers will say that what they do is perfectly legal. But they said that about [insert your favourite perfectly legal plan where APNs have now been received].

In the past, HMRC had difficulty to spotting this sort of thing. But the new online share plan reporting requirements have extra questions that allow HMRC to assess the risk of tax avoidance. One of these is to ask whether the shares are part of the largest class of share in the company.

For the avoidance of doubt, what I am saying on the alphabet share point has nothing to do with the normal salary/dividend choice where there is a single class of share.

The other side of all this is implementing it properly. What protections will there be for you if you fall out with your kids or they divorce?

Let me get this straight. You are saying HMRC will assign a value to the B shares if they pay dividends and assert that the value as well as the dividend is subject to income tax and NIC? Would that be true for my wife's and my B shares as well? But they won't do that for the A shares?

Note that the company has never existed and the shares have never received a dividend. This is a complete start-up. If the B shares don't pay any dividend for nine or 12 months, can they say they had any value at start-up?

I did Google as you suggested. Most of what I've found on "alphabet soup" refers to the PA Holdings case where there was an attempt to avoid corporate tax as well as NIC, and references to restricted shares with no voting rights or rights to capital. I've not found anything that says anything about some kind of value being set retroactively on shares once they start paying dividends. And I've found several references to HMRC not objecting to alphabet shares given to founding shareholders to reflect their different roles in the company.

To go back to my main question, based on your reply you would consider this a very aggressive structure, is that correct?

(As to the question about what happens if family falls apart, if necessary we can wind up the company and create a new one. I'm not intending to retain any significant assets in the company for any long period of time. And my wife and I control over 90% of the shares, so chances are good we can handle any problems anyway.)

[Iliketax]

PA consulting is very different. Did you find HMRC's example 3? Securities with Artificially Enhanced Value

I would ask your accountant about this.

[WordIsBond]

PA consulting is very different. Did you find HMRC's example 3? Securities with Artificially Enhanced Value

I would ask your accountant about this.

Thanks, I didn't find that. I presume this is the part you were talking about:

Example 3: alphabet soup
A company uses special classes of shares to pay all or most of employees' wages as dividends. Each employee will have their own class of shares so different dividends can be paid to each. The shares have no rights other than that the employer can award dividends at his discretion.

I think we are not vulnerable to that. 1) "All or most" doesn't come into play, since my kids will be getting more salary than they will be dividends. 2) There won't be different classes for each employee. Every shareholder will have some Class B shares. 3) The shares have other rights than dividends.

But you are right, I'll press my accountant on this.

[northernladuk]

Do you actually earn enough from your contact to actually make this all actually worth it??

Giving shares to you kids spouses.. Whatever class... Why would you do this?
I'd agree with point 4 and 5 re different class shares and wage for wife.

If I was the taxman and saw that horrible mess I'd definitely be over for a closer look. Are there no better options for your kids? Contract direct with their own set ups? Have you got contracts of employment set up with everyone?

Is this gig going to come to an end in then near future and what are the chances of getting this setup at another client. Changing share structures too regularly is also going ton attract unwarranted attention. Setting up a load of class B shares and then pulling them not so long after looks a bit suss for example.

[WordIsBond]

Do you actually earn enough from your contact to actually make this all actually worth it??

Giving shares to you kids spouses.. Whatever class... Why would you do this?
I'd agree with point 4 and 5 re different class shares and wage for wife.

If I was the taxman and saw that horrible mess I'd definitely be over for a closer look. Are there no better options for your kids? Contract direct with their own set ups? Have you got contracts of employment set up with everyone?

Is this gig going to come to an end in then near future and what are the chances of getting this setup at another client. Changing share structures too regularly is also going ton attract unwarranted attention. Setting up a load of class B shares and then pulling them not so long after looks a bit suss for example.

Lot of questions, I'll try to cover the bases.

Re: making enough, continuing work.... Current contracts total between £80-90K over six months. Have already turned down one contract that would pay more because we were committed -- they said they'd hold it until I'm free, but I don't know if they will. Given my reputation in our niche industry, I'll have all the work I can handle for as long as I want with plenty of opportunities to take on work I can pass on to my two kids. Within a year or two will be billing for work done by the third as well (more training needed first).

Re: kids setting up on their own... They couldn't possibly do as well completely on their own. The industry will pay them more if I'm on the contract and supervising them. That would also bring IR45 into play. Maybe in a few years as their knowledge, experience, and reputation grows. Huge factor for me in going independent was to be able to set up the kids and get them really entrenched with a reputation in the industry.

Re: shares to spouses.... Our view of family / joint ownership in marriage might not be in line with everyone here. Let's leave it as I'm willing to give the shares. My question is whether my accountant is aggressive on the tax ramifications in saying this is fine. My sense is that if it is ok to give shares to my kids it is ok to give them to their spouses, and it is perfectly ok to give shares to my kids. The only thing risky here is the different classes, and that is perhaps somewhat mitigated by the fact that I also hold B shares.

Re: horrible mess.... Maybe it looks like a horrible mess because you are a sole independent contractor and I'm running a family consulting business? Probably few people here like me. Maybe I'm asking this question on the wrong forum, though I'm not sure on which forum I should ask it....

[northernladuk]

I just don't get the spouses bit. Golden rule tends not to be mix money and family but in this case you've got it sorted but spouses as well? Maybe it's just me but that's too tenuous when my business is concerned. Give them to your kids and let them sort it out as they want. It just looks highly suspect spreading it so thin and adds to risks of splits and divisions which you don't need to do.... Unless they are just tax mules to keep everyone under the threshold............

Anyway, looks like you've done your homework so keep us updated. I'd be interested to see what the outcome of the alphabet shares carry-on is. I'd certainly be taking a second professional opinion on that.

[SueEllen]

I just don't get the spouses bit. Golden rule tends not to be mix money and family but in this case you've got it sorted but spouses as well? Maybe it's just me but that's too tenuous when my business is concerned. Give them to your kids and let them sort it out as they want. It just looks highly suspect spreading it so thin and adds to risks of splits and divisions which you don't need to do.... Unless they are just tax mules to keep everyone under the threshold............

Anyway, looks like you've done your homework so keep us updated. I'd be interested to see what the outcome of the alphabet shares carry-on is. I'd certainly be taking a second professional opinion on that.

WHS

I don't know what the OP kids' spouses do but giving them shares or even embroiling them in the family business could have negative financial and employment implications for them.

[TheFaQQer]

I've read a lot (here and elsewhere) on income splitting / wife as shareholder and/or director. AND, I've talked to my accountant. But I've only recently become a consultant, and I don't have a long-term relationship with an accountant, so I don't yet know how much I trust the guy I'm using.

If you are worrying about trusting your accountant, that doesn't necessarily bode well for the future. How did you find them? Did someone recommend them - and if so, do you trust their judgement?

Background: I've been happily married for several decades, and trust my wife completely (my accountant found a diplomatic way to ask about this before advising, which I see as a plus for him). I have two kids working for me doing billable work for clients (and a third doing a little bit of non-billable work on a project I've got going). My consulting work is bringing in a lot more than my kids' work. My kids want to be paid salaries to have salary history for when they do buy a house. (I know contractors can get mortgages, but it isn't always easy.)

Is this going to be an on-going thing? What happens when the contracts end? Will they find more work - and if so, how? Are you / they working through an agency or direct with clients?

Recommended company structure:
Two classes of shares, with equal voting rights. Class A (more than 80% of the shares) is split evenly with my wife. Class B is divided proportionally based on income being brought into the company. Each of us (me and my kids) divide our Class B shares equally with our spouse. My wife and I each get 5 Class B shares, Offspring #1 & spouse each have three, and Offspring #2 & spouse each have two. (No spouses have more than £3K other income.)

What happens when Kid 2 does more work than Kid 1? If you are going to structure it like this and pay dividends, then how will that work?

If you are intent on doing this, I would consider:

Class A shares x 2 - 1 for you, 1 for wife. These are the only voting shares.
Class B shares x 2 - 1 for kid 1, 1 for their spouse
Class C shares x 2 - 1 for kid 2, 1 for their spouse

That way, the board (you and your wife) can dictate what level of dividends to pay out for each class of share and can make sure it's in the right kind of proportions - no chance that kid 2 does more work, but kid 1 gets paid more.

I know it's not quite the same thing, but I know a consultancy that did it this way when they started out - 4x class A shares (1 each) then a class B, C, D, E one of each for each of the founders.

My current understanding:
1. Splitting shares equally between my wife and I is entirely in the clear under current legislation.

Correct

2. Giving shares to my kids and their spouses should be in the clear as well.

IIRC, there is a specific reference to giving shares to children in the legislation, but I may be wrong.

3. Paying salaries to my kids is helpful because it helps to say to HMRC, "This is a normal family business," and reduces risk of investigation, etc.

No idea whether paying a salary helps if HMRC start questioning your dividends. It does mean that if they investigated and won that there's less tax to pay because you've already paid it.

4. Having two classes of shares IS aggressive and could draw unwelcome attention from HMRC.

Don't know

5. Not sure about paying my wife £8K -- does her position as director (and the responsibilities and potential liability that entails) justify it? This seems aggressive to me, but I don't know enough.

Don't know