Matters of life and death

With asset values climbing and thresholds frozen until 2018, capital gains tax (CGT) and inheritance tax (IHT) revenues already total more than £7.3bn and are set to rise.

Financial planners need to understand the interaction of these life and death taxes in order to take action and minimise their impact.

Gifting is at the forefront of most IHT plans. However a gift is a disposal for CGT purposes. The donor is considered to have received full market value for the assets, meaning that a gift for IHT purposes may trigger a CGT liability.

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On death, executors can distribute assets free of a CGT liability and the beneficiaries receive them with a base cost at the date of death.

The gain is “washed through” and this rebasing is potentially valuable. However, given that the assets are distributed at death, this may trigger an IHT liability.

Consideration should be given to which route is preferable: gifting assets during lifetime that carry a large capital gain subject to CGT at 18 per cent or 28 per cent, or wait until death and a 40 per cent IHT charge.

It is also important to say these tax rates are rarely paid; the average tax rate paid across all gains on all assets taking into consideration the various exemptions will usually be lower.

For example, if a gift valued at £150,000 saw total gains of £50,000, once the annual allowance of £11,000 had been taken into account – for a higher rate tax payer – CGT would be applicable at 28 per cent of the remaining £39,000, or £10,920. Thus CGT is paid at a rate of 21.8 per cent of the full £50,000 gains.

There may be occasions where it is preferable to pay CGT at 18 per cent or 28 per cent in order to remove assets from the estate and reduce the 40 per cent IHT liability on death. The success of this planning would depend on how long the donor lives; if they die within seven years then the gift will have been subject to both CGT and IHT. Therefore, the donor must have a reasonable life expectancy in order for this planning to be effective. An example is outlined in Box 1.

Note that because the base cost for CGT is reset on death, where an individual is holding an asset with a particularly large gain and/or the asset is not fully liable to IHT (for example, it benefits from business property relief (BPR) or the estate falls within

the nil-rate band), it is generally preferable to hold onto the asset, thereby avoiding both CGT and IHT on death.

Hold-over relief

Hold-over relief allows the donor to gift assets without incurring a CGT bill. This is particularly useful where the donor may not have suitable liquid assets to pay any CGT. Where hold-over relief is claimed, the donor’s base cost is carried over to the beneficiary.

Hold-over relief is available where a disposal is a chargeable transfer for IHT purposes (ie, it is not available for potentially exempt transfers).