Article curated by Assistant Manager Conor McManus
With the financial impact of Covid-19 clear to see, many of our clients have been in touch to ask for our thoughts on what the future tax landscape could look like.
While we should always be cautious in trying to second guess future changes, inevitably the tax landscape will need to change to fund the (much needed and welcomed) Covid-19 financial measures currently being offered to small businesses and the self-employed.
The next budget will be Autumn and we expect the Chancellor to consider raising VAT, changing the taxation rules for the self-employed, increasing CGT rates or indeed putting a greater number of asset classes in the category which is subject to higher rates (currently UK residential property and carried interest). However, in the context of IHT, we would expect that the Chancellor may also consider if now is the right time to change the IHT rule book altogether.
With the above in mind, we are working with several clients to implement IHT planning now and over the summer period while the current IHT rule book is known and in force.
Gifting assets – is now the right time?
Deciding when to leave assets to the next generation is never an easy decision, both commercially and financially. On top of giving up control in the assets, there are a number of tax implications which must be carefully considered before simply gifting assets to children. For tax purposes, the larger the amount given away, the larger the potential tax liability. Given the current downturn in the economy and financial markets, we discuss some options below regarding why giving away assets now could be beneficial in both the short and long term from a tax perspective.
When an asset is gifted to a connected party, child, grandchild, brother etc, there is an immediate disposal for Capital Gains Tax purposes. This means that although no consideration is received for the asset, the donor will still be liable to a Capital Gains Tax charge. The asset is valued at the date of the gift and this is deemed to be the proceeds received, the cost in calculating the ‘gain’ is the initial cost of purchase for the donor. Please note that gifts to spouses/civil partners are free of capital gains tax and gifts of cash are also not subject to capital gains tax.
In some cases, the gain on disposal can be significant and it is the donor who will have to find the cash to pay the Capital Gains Tax charge. This can lead to cashflow problems.
Potentially Exempt Transfer (PET)
The gift will also be treated as a Potentially Exempt Transfer (PET), for inheritance tax purposes. This means that if the donor was to pass away within 7 years of making the gift, a charge to inheritance tax would arise. If the donor survives for 3 years after making the gift, the total inheritance tax payable is reduced on a sliding scale, dependant on the number of years survived.
The value of the PET is the value of the asset at the date of the gift, and inheritance tax is charged at 40% on the value of the PET that exceeds the donors nil rate band. The nil rate band is currently £325,000.
What is the advantage?
A clear advantage of gifting assets when their true value is ‘depressed’ is that the asset is valued for both capital gains tax and inheritance tax purposes at the date of the gift. This will reduce both the capital gains tax immediately payable and the potential inheritance tax payable.
Another advantage to the donor is that if a PET is made and the value of the asset given away is worth less at the date of death than the date of the gift, the lower value is substituted into the inheritance calculation. On the reverse, if at the date of death the asset is worth more than at the date of gift, the value at date of gift is used for inheritance tax purposes.
This could be particularly useful in cases where the donor holds a stocks and shares portfolio. Particular shareholdings could be selected that are either showing a capital loss or very small gain, that when gifted away either result in a chargeable gain within the annual exemption or a small taxable gain. This will reduce the capital gains tax payable, potentially to nil, and the value of the PET within the nil rate band. On top of this, stocks and shares are generally assets which should be held for the long term, passing the shares to the next generation at this currently reduced value, not only locks in reduced tax rates but also removes the potentially capital accumulating asset from the donors estate at an early stage.
Gifting the assets away will fully relinquish control to the beneficiaries and so the donor must be suitably prepared that he may not recall the assets if he should find himself in financial difficulty.
Alternatives to outright gifts
We appreciate that giving control to the next generation is often either difficult or indeed can be inappropriate in cases of young age, vulnerability or even concern over future partners.
We often speak to our clients about alternative structures which will allow wealth to provide for the next generation but will do so in a way which overcomes some of the practical concerns associated with gifting assets. Two ideas which are popular topics of conversation are 1) the use of trusts and 2) family investment companies.
The use of trusts
The main issue with gifting assets is that control over the assets is fully removed from the donor, and the donee is free to do as he pleases with the assets. The assets are now fully owned by the donee. Passing wealth to the next generation is often delayed because of this issue over control. It is usually not favourable to pass on high valued assets to children as they may be deemed not responsible. One common way of combating this is through the use of Trusts.
This article will not go into the depth on the mechanics of trusts but as an overview, the donor/settlor will place funds into a trust and trustees will be appointed. The trustees have control over the trust assets and must administer the trust according to the terms of the trust. The beneficiaries of the trust will receive income or capital from the trust fund, but this is usually over a longer period of time, to avoid the assets immediately vesting in the beneficiaries.
Chargeable lifetime transfer (CLT)
The gift of an asset into trust is treated a chargeable lifetime transfer (CLT), this means it is immediately chargeable to inheritance tax, unlike PET’s. The gift into the trust is also a disposal for capital gains purposes. However, since there is a charge to inheritance tax, the capital gain can be ‘held over’ and so the trust is deemed to acquire the assets at the same cost as the donor. Please note an election is required in order to claim holdover relief.
The inheritance tax charge is calculated based on the value of the asset at the date of transfer, less the available nil rate band, and the excess is taxed at 20%. This is payable by the donor.
Why consider a trust?
Much the same advantages apply to a donor putting assets into a trust, as it does to gifting assets outright. The reduced value of the assets will reduce the capital gains tax potentially payable by the donor, although since the assets can be transferred free of capital gains tax this is not a major consideration. The value of the CLT will be based on the value of the assets at the date they are transferred to the trust, since this amount is immediately chargeable to inheritance tax it is useful to keep the total value either, within or as close to, the nil rate band as possible. Given the depressed value of the market, now could be a good time to transfer assets into a trust, for both the immediate inheritance tax saving on the inheritance tax saving on the CLT and removing the assets from the donors estate, before the assets return to their higher values.
The assets inside the trust, once the beneficiaries are of responsible age, can be transferred to the beneficiaries outright. Any capital gain can again be held over so that the beneficiaries are deemed to acquire the assets at the original donors cost. There is an inheritance tax charge on capital distribution from the trust, however if this is done within 10 years of setting up the trust, and the initial value transferred to the trust was under the nil rate band, no inheritance tax charge will arise – regardless of the size of the trust at the date of distribution.
Therefore, assets currently worth £325,000 (in a depressed market), can be transferred, in and out of a trust, to a beneficiary almost 10 years later with no tax implications. On top of this the potential value of the assets could be significantly greater with the markets returning to normality.
Any assets held in trust will fall outside a donors estate, provided the transfer to the trust was over 7 years before death. There are additional administration burdens in respect of trusts which should be considered. If you are considering setting up a trust please get in touch with our trusts team.
Family Investment Companies (FIC)
A Family Investment Company (FIC) is a bespoke family investment vehicle in the form of a company whose directors and shareholders are, usually, individual family members or those close to you.
A FIC can be set up by an individual by way of an initial loan to the company, the initial cash can be funded by either current cash holding or the sale of assets. The sale of any assets would of course be subject to capital gains tax and so the potential liability should be analysed before sale. Again, due to the current ‘depressed’ value of assets, now could be a viable time to sell assets for reduced gains in order to fund the use of a FIC.
Why consider an FIC?
A FIC can be used to hold a wide variety of assets including property and stocks & shares. It is a flexible investment vehicle that allows a family to determine how each member can benefit by defining the rights attached to each class of shares. If the company is correctly structured it allows the principal to retain control of the company by way of holding voting rights, however, allows the beneficiaries, usually the settlors children, to hold income and capital growth shares. The effect is to remove the capital growth value of the company from the principal’s estate and pass this onto the beneficiaries, in turn reducing the total IHT that should be payable on death.
As a long term structure, a FIC is tax efficient since the corporate tax rates are smaller than an individual. Note that these are the top rates of tax for an individual.
|Tax on dividend income||Nil||38.1%|
|Tax on interest||19%||45%|
|Capital gains tax||19%||20% on assets|
28% on residential property
As an example, an individual who holds investment property and a stocks and shares portfolio, which both sit at relatively small current gains, may decide to set up an FIC and gift these assets to the company.
Any future growth of the assets would accrue to the company capital growth shares held by the beneficiaries and so this increase in the value of the assets would all be outside of the individual’s estate for IHT purposes.
Any income produced by the assets will be taxed at the favourable corporate tax rates and dividends can be paid to each of the beneficiaries year on year to make use of the dividend allowance. This allows for a controlled stream of income to the beneficiaries, so that although they hold the capital shares they are unable to immediately access the cash. The underlying assets cannot be sold by the beneficiary since the principal retains the voting rights.
Is it time for your to consider you IHT exposure?
As described above, the use of a FIC retains significant control while both reducing the principal’s IHT liability and helping to provide for their children’s future in a tax efficient way.
Given the current depressed market, now could be an ideal time to shift assets into a FIC.
It is also possible to incorporate a hybrid of both Trusts and FIC’s for greater control. If you would like further details regarding the use of FIC’s please do not hesitate to get in touch.