TT22: Tax and children

In this issue of Topical Tips we consider the expensive issue of raising children. Most readers will welcome financial help from any quarter, particularly the Inland Revenue. Before this can happen the fundamental problem that has to be addressed is anti-avoidance legislation.

This exists to prevent parents gaining a tax advantage from arranging income to be generated in the hands of their minor (and unmarried) children. (Clearly, it would nice for parents if they could somehow transfer income that would otherwise be taxable at 40% to their children in whose hands there might be little or no tax to pay.)

Beware the triple condition

The anti-avoidance legislation attacks the situation where income arises to a minor child as a result of action taken by the child’s parents. Thus, there are three conditions that need to be side-stepped. The first to avoid is ‘parent’. If you have minor children and would like to generate income in their hands, help from grandparents, uncles etc will be a good way forward.

Often though, a direct gift to the children of capital to generate the requisite income will be deemed to be inappropriate. However, the capital can be held in trust and it is often possible for the income-producing asset to be a particular class of share in the family company. The second condition is ‘minor child’. When the child attains the age of 18, the legislation has no effect!

Thus, it is usually possible for the parents’ capital to be used to generate income for children embarking on higher education. Again trust arrangements are considered sensible to prevent the underlying capital being wasted. Again, a particular class of share in the family company is often a suitable asset for this purpose.

The third condition is ‘income’, so the anti-avoidance legislation does not apply to capital gains. It should be borne in mind that even minor children can have tax-free gains of £7,700 for the current tax year. Thus, it would be possible for a wealthy parent to make a gift to a child that could be invested in stock exchange type investments geared towards capital growth. Any income arising would be taxable on the parent, but any gains would be treated as the child’s for tax purposes.

An alternative strategy would be to invest in assets that produce no income at all but which produce returns wholly within the charge to capital gains tax. An example of such an asset is a second-hand endowment policy.

Barnes Roffe Topical Tips

  • Sizeable tax savings can be achieved if income and/or gains can be generated in the hands of non-taxpaying children.
  • Often, the income can be produced in the form of dividends from family companies.
  • The use of trust arrangements is usually desirable so that large sums of capital are not given outright to children to use as they please!
  • For minor children, capital from e.g. grandparents is often a good way forward.
  • Remember, gains are not treated as income.
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