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.
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).
The most common situations where hold-over relief is available are for transfers into trust that count as chargeable lifetime transfers and transfers of assets eligible for business property relief (such as unlisted shares).
Both the transferor and the transferee must jointly apply for hold-over relief. If the gift is into a trust then only the transferor need claim the relief. See Box 2 for details.
Hold-over relief cannot be used to gift listed shares (ineligible for BPR) but can be used to gift qualifying Aim shares and potentially to a child using a designated account arrangement.
Listed shares such as those in the FTSE 250 can be gifted to discretionary trusts and the gain held over, although care is needed to ensure the value of gifts do not exceed the nil-rate band and trigger an immediate IHT charge.
Hold-over relief can also be used for distributions from discretionary trusts to beneficiaries.
The trust will have a maximum CGT exemption of half the personal exemption (ie £5,500 for 2014/15, then divided by the number of trusts settled) and all gains above this exemption will be chargeable at 28 per cent.
A beneficiary will have a full annual CGT exemption available to them (£11,000 for 2014/15) and all or part of the gains may fall into the 18 per cent CGT band.
Therefore, by distributing shares to the beneficiary for them to sell rather than selling within the trust, the CGT liability can be significantly reduced or even completely eliminated.
Danny Cox is head of financial planning at Hargreaves Lansdown
