Don’t put shares into your children’s names!

Over the years (and there have been quite a few!!) I have often been asked by clients about investing money into shares for young children – so as to build up investment balances “over the next 20 years or so”.

Whilst the intention is great, there are potential problems with issuing shares to minors (ie  children under 18).

While the Corporations Act 2001 dictates that a company director must be at least 18 years of age, it does not have a similar requirement regarding the holding of company shares. In the absence of any requirement in a company’s constitution, there appears to be no legal reason why shares cannot be registered in the name of a minor.

However, for very good legal reasons, shares should be registered in the name of a parent or guardian as trustee for the minor holding those shares.  Alternatively, set up a little share -holding trust with Dad and Mum as Trustees and invest in the shares through that.  This trust can cover investments for multiple children and provides greater flexibility.  It also provides protection in case the child goes ‘off the rails’ for any period of time!

Some reasons why:

Tax reasons

If a minor owns shares that do very well – (they may be sold because they are taken over at an extreme price, or they are just too high a price not to sell) then the resultant net taxable capital gain will be taxed at penalty rates (as high as 66%) where the child is still under 18.

Also, if dividends paid on the shares (together with other investment income; eg interest) total more than $416 in a year, the child is also taxed at penalty rates (as above).

However, if the shares were held in a trust, then the same capital gain and investment income may well be able to be distributed to another family member over 18 with substantially less tax.

Contractual issues

Minors are not considered to have legal capacity. This is the primary reason why they are not able to enter into contracts (with some limited exceptions). This can create difficulties where minors are the registered owners of company shares (or units in a unit trust), including:

  • The minor is not bound by the company’s constitution, which is a form of contract;
  • Minors are unlikely to be able to enter a binding contract to sell or transfer shares;
  • Minors cannot vote at meetings of shareholders nor make a binding proxy to enable a vote at company meetings;
  • The contract to acquire the shares may not be valid;
  • Minors may not be able to open bank accounts, resulting in difficulties cashing a dividend payment;
  • Minors may not be able to enforce the company constitution against other shareholders or directors;
  • Minors cannot enter into legally binding shareholder agreements;
  • The Corporations Act 2001 requires that shareholders provide their consent to becoming a shareholder, which minors are not legally able to do; and
  • Minors can repudiate the allotment of shares at any time during their minority or before they ratify the allotment on turning 18.

Also, for any contract involving a minor to be binding, it must be legally ratified or affirmed once they turn 18. In the absence of ratification or affirmation, the contract remains unenforceable even after the minor acquires legal capacity.

CHESS procedures also recommend against a ‘minor’ holding shares in listed companies for all the above reasons. Additionally, brokers processing transfers of listed shares are obliged to indemnify the relevant company against any loss associated with a share transfer from a minor. Potentially, where a minor transfers shares and then challenges the transfer once coming of age, the broker may be liable for damages as a result.

At a minimum, it is recommend that shares are held for a minor by a parent or guardian, using a declaration of trust which makes it clear that the shares are held non-beneficially.  Once the minor turns 18, or later, (if appropriate) the shares can be transferred by the “trustee” into the name of the child without any duty or CGT consequences.

Where the investment level is expected to be significant over a number of years it is recommended to use a simple Trust structure.  This provides significant tax benefits – however does not allow for the shares to be transferred into the child’s name without tax exposure.  This is done by ‘Dad and Mum’ resigning as Trustees and the child taking over (effectively then being in total control – the same as if they owned them directly).

As can be seen – there is a bit more to think about than just buying a few shares for the kids!

(Acknowledgement:  Much of the technical content re “Contracts and Chess” is taken by an article by Stephen Harvey of ACIS)