Lifetime Gifts The Principal Tax Considerations BRIEFING

Transcription

1 Lifetime Gifts The Principal Tax Considerations BRIEFING Why give at all? Assuming that the older generation can afford it, the children (or indeed grandchildren) will always welcome some financial help, for example for investing in a house or to meet other capital needs. And, if you are giving your hard-earned cash, you might as well do so tax-efficiently. This primarily means with a view to mitigating the ultimate Inheritance Tax (IHT) liability on death. In this Briefing we set out to highlight the principal UK tax considerations which you should bear in mind when making gifts though the specific application will depend on your particular circumstances and plans. General Considerations Quite apart from tax, there are two guiding principles: You should never give away more than you can reasonably afford, bearing in mind that, as we all live longer, care costs continue to rise inexorably Never discount the possibility that a gift might have an adverse effect on the recipient. Again, much will depend upon their age and character as to whether or not they are likely to put the gift on Lucky Strike to win the 2.30 at Lingfield. Unfortunately, the traditional response to this, to make a gift in trust, has been made rather more difficult since March 2006, except where the amount does not exceed 325,000 (broadly). IHT in a Nutshell IHT is primarily a death duty, but also to a lesser extent a tax on lifetime gifts. Calculating the chargeable estate On death the estate on hand is, subject to various exemptions and reliefs, liable to IHT. The principal exemption is that value passing to a surviving spouse or civil partner, whether outright or on trust (as an immediate post-death interest or IPDI), is exempt from IHT. This is subject to the qualification that, if the deceased spouse/civil partner is domiciled in the UK but the survivor is not, the exemption is limited to 55,000 on a lifetime basis. Note that Budget 2012 announced a consultation which may lead, from 2013/14, both to an increase in the exemption to say 325,000 and the possibility for a non-uk domiciliary to elect to be UK domiciled for IHT purposes (for which one cannot envisage a very high take up!). Page 1 of 9

2 Added to the general law of domicile is a special IHT rule, so that if not ordinarily UK domiciled (not the same as residence, viz domicile is one s permanent home), a person will also be treated as domiciled for IHT purposes if: They have been domiciled in any part of the UK within the previous three calendar years; or They have been resident in the UK for at least 17 out of the last 20 tax years (6 April to 5 April). Property passing to charity is also exempt. The most significant reliefs are for qualifying business or agricultural property (each a subject in itself), at usually 100% of the value, though in some cases just 50%. Added to the value of the estate on death (including a share in any jointly held property) will be certain other property, to produce an aggregate chargeable value, as follows: (a) The value underlying a qualifying interest in possession in a trust under which the deceased had the right to enjoy the income, typically either where the trust arose on death or, if under a lifetime settlement, one made before 22 March One exception to this is where the trust was made by a person domiciled outside the UK for IHT purposes where the trust property is situated outside the UK (a so-called excluded property trust ). (b) The value of any property given away since 18 March 1986 in which the deceased had reserved a benefit either at death or within the seven years preceding death. If such a benefit had come to an end during those seven years the deceased would be treated as making a potentially exempt transfer (or PET) which has now become chargeable, to be treated as in the next paragraph. The rate of IHT The first 325,000 (the nil-rate band) is charged at 0%, with the balance at 40%. Any chargeable gifts made in the seven years preceding death, valued as at the date of gift, have first call on the nil-rate band, which is accorded in order of the gifts: any excess over the nil-rate band is charged at 40% at death. To the extent that any property on hand by death was itself subject to IHT within the previous five years, eg an inheritance from say a favourite uncle, the tax chargeable on that portion is reduced by a percentage of tax charged on the first transfer - on a sliding scale depending on the period elapsing between the two transfers (called quick succession relief ). Significantly, if at least 10% of one or more of three components of the chargeable estate (the settled estate, property passing by survivorship under a joint tenancy to the surviving joint owners - or the free estate) is left to charity, the rate of tax on the balance is reduced from 40% to 36%. This is a new provision applying to deaths on or after 6. Page 2 of 9

3 Insofar as property is subject to death duties in some other jurisdiction, there may be a relief against the UK tax charged. The important point is that all property owned at death potentially comes within the IHT charge, subject to exemptions or reliefs. Property must be valued on an open market basis, including personal chattels (house contents, personal possessions and so on). Also charged on death is the value of any pension funds on hand at death, insofar as not required to pay a pension to a surviving spouse/civil partner or financial dependant or indeed charity. (This charge does not apply to pension funds where no benefits have been drawn and death occurs before age 75.) This value will be subject, not to IHT, but to a special tax charge at 55%. We should say for completeness that the above is a very brief summary only and should not be taken as a comprehensive review. However, on this basis, you should be able to work out roughly (perhaps using the outline table in Appendix) what the potential IHT bill might be on your death and therefore whether you might like to think about taking some action now to mitigate it. Remember that the total value of chargeable gifts made in the preceding seven years is added to the above, both in allocating the nil-rate band and in charging any excess over 325,000. Also, under the transferable nil-rate band rule introduced in October 2007, any proportion of the nil-rate band which was unused on the first death within a marriage/civil partnership (whenever that occurred), can be carried forward and added to the nil-rate band available on the second death. In effect therefore, taking a couple as a single entity, you can deduct from the combined chargeable total of the two estates 650,000 at present levels, to see how much is left to be charged at 40% on (typically) the second death. Capital Gains Tax There is, generally, no Capital Gains Tax (CGT) payable on death. That is, any inherent gain (or indeed loss) in an asset (for example, an investment) is effectively washed, so that the beneficiaries inherit the asset at market value at death for CGT purposes. There is one exception to this principle, for assets within a qualifying interest in possession trust where the gain on settlement of the asset was deferred by hold-over relief. The held-over gain comes into charge on death of the beneficiary. By contrast, where it is an individual who owns an asset which she/he was given with the benefit of hold-over relief (whether by trustees or by another individual) the held-over gain is washed : a significant advantage to ownership by an individual. How do you stand? If, on perhaps a back of the envelope calculation, you estimate that a significant IHT liability will arise at some stage and bearing in mind the overriding caveats mentioned above you would rather benefit your family than the Chancellor of the Exchequer, you might like to consider some options for lifetime Page 3 of 9

4 giving. The aim would be to reduce the size of the potentially chargeable estate on death. Other options for mitigation might include either acquiring (or enhancing the value of) property attracting agricultural or business property relief or indeed writing in trust life policies not already in trust. Lifetime Giving CGT While it might seem a bit odd to start with CGT, you should remember that a gift is just as much a disposal as is a sale. Cash, whether in sterling or (since 6 ) foreign currency, is not a chargeable asset, nor indeed normally is one s only or main residence (though, as discussed below, reservation of benefit considerations may make this an unsuitable candidate for a gift). There are some circumstances in which relief on the only or main residence may not be given in full. There are one or two further small exemptions. For example, a gift of stocks and shares now worth 100,000 which were bought for 60,000 will trigger a gain of 40,000. Subject to the annual exemption of 10,600 for 2012/13, CGT will be charged at 28% or (to the extent that your basic rate band for Income Tax purposes is unused) 18%. Here, however, there may be one advantage of making a nil-rate band trust (ie, of up to 325,000 below), as the gain can be held over, so that you pay no CGT and the trustees assume your historic base cost. Trustees have an annual exemption of at maximum 5,300 and any gains made by them are taxed at 28%. However, trustees also can, subject to anti-avoidance principles, hold over a gain on transferring a chargeable asset to a beneficiary. For this, the asset must be in the trust for at least three months and it must be obvious that the trust was not simply being used as a conduit to save CGT. Stamp duties A gift of stocks and shares will not attract Stamp Duty, nor will a gift of land or buildings attract Stamp Duty Land Tax (SDLT), unless the asset is subject to a mortgage which the donee takes on. In that case the amount of the mortgage will be treated as the price that the donee pays for the transfer of the asset, so, if residential property and the mortgage exceeds 125,000 (or commercial property 150,000) there will be an actual SDLT liability. Even if the amount is less than that, there will be forms which have to be submitted to Her Majesty s Revenue and Customs (HMRC) Stamp Taxes within 30 days after the gift. VAT A brief word about Value Added Tax (VAT) is necessary. The gift of a business will generally be outside the scope of VAT as a transfer of a going concern. However, a gift of an asset within a business which is standard-rated may well attract VAT at 20%. For example one might run a business of furnished holiday lets: a gift to a son or Page 4 of 9

5 daughter of a cottage within the business will trigger a charge to VAT at 20%. IHT The Lifetime Exemptions Potentially exempt transfers (PETs) A gift to an individual (or to a trust for a disabled person) which the donor survives for seven years is exempt. If death follows within seven years, the gift has first call on the nil-rate band, according to the order in which the (now chargeable) gifts were made. Where the gift exceeds the nil-rate band and so IHT is chargeable and death follows at least three years after the gift, tapering relief is available. There is, in one unusual circumstance, a 14 rather than a seven year trap. This occurs where a PET is made which the donor does not survive for seven years and within seven years before the PET a chargeable transfer had been made, eg a gift to a trust. Any appreciation in value between the date of gift and the date of death within seven years effectively escapes IHT so far as the donor is concerned. The corollary is that any fall in value is not relieved, as the chargeable value is that at the date of the gift unless the gift exceeds the nilrate band, in which case an election can be made to substitute the lower value at the date of gift. The spouse/civil partner exemption applies to lifetime gifts just as it does to gifts on death, including the limitation for non-uk domiciled donees. Tax Tip Before planning a sizeable PET, consider whether any chargeable transfers have been made within the previous seven years. And in selecting assets for the PET, favour those that are more likely to appreciate in value and which do not produce income which you can ill afford to lose. Ensure that there is no reservation of benefit: if the donor does reserve a benefit (without paying fully for it), the asset will not effectively leave your chargeable estate until such time (if ever) as the benefit ends. Normally, reservation of benefit is not a problem with gifts between spouses/civil partners. However (unusually), where the donee is non-uk domiciled for IHT purposes, the reservation of benefit rules may apply where the limited 55,000 exemption (subject to any increase) has been exhausted. The annual exemption Gifts of 3,000 in a tax year are exempt. An allowance which is unused in one year can be carried forward for the next year (only). Assume therefore that you gave 1,000 within this exemption during 2011/12; for 2012/13 you have 3,000 for 2012/13 plus 2,000 carried forward from 2011/12. Regular use of this exemption is advisable, if you can afford it. Over a 10 year period you can get 30,000 free of IHT out of your chargeable estate (or 60,000 per married couple/civil partnership), saving at least 12,000 or 24,000 respectively. Page 5 of 9

6 The simplest way to use the exemption is to give cash, although you could also make a gift in kind, e.g. a painting worth 3,000. You might chose to pay premiums on a life assurance policy on your life written in trust for your children. Or you could set up or pay into a stakeholder pension for a child or grandchild. You could pay 2,880 net, ie within the annual exemption (which represents the maximum contribution of 3,600 gross less 20% basic rate tax). Here you hope that there will be long-term appreciation for the child or grandchild and (which you may consider an advantage) benefits cannot be taken until age 55. The 250 small gifts exemption You can make gifts of up to 250 to any one individual in a tax year as exempt, though not in conjunction with the 3,000 annual exemption. This is intended to cover birthday presents, Christmas presents and the like. This exemption is per donee, whereas the annual exemption is per donor. The normal expenditure out of income exemption If you have sufficient left from your annual income after paying all normal expenditure (including Income Tax), the balance can be given away, IHTexempt. Income will of course very often fluctuate from year to year and this exemption is very flexible. Taking one year with another, you need to be able to show is that you have enough net income to maintain your usual standard of living, ie without resort to capital. Careful records should be kept. Once seven years have elapsed from a particular gift to an individual, it will of course become exempt. The marriage/civil partnership exemption When a son or daughter (or step-son or stepdaughter) gets married or enters into a civil partnership, a gift will be exempt depending on the relationship between donor and donee: 5,000 for parents; 2,500 for grandparents; and 1,000 for all others This gift must be outright, though it can be made into certain types of trust. The gift can be cash or in kind. The charities exemption A gift to charity which is made during your lifetime is exempt just as much as on death. One advantage of lifetime gifts is Gift Aid Income Tax relief, both basic rate recovery for the charity and higher rate relief for the donor (with no limit). So, for example, if you are a 50% taxpayer and you write a cheque of 10,000 to charity this takes effect as a gross gift of 12,500. The charity reclaims 2,500 (20% Income Tax deducted at source) and you will recover a further 3,750 in your self assessment (30% of the gross amount). Other exemptions There is a variety of other exemptions from IHT, eg gifts for national purposes, gifts to employee trusts and so on. Page 6 of 9

7 Gifts into settlement Some lifetime gifts are not PETs, but rather are immediately chargeable transfers. The principal among these are gifts into settlement (other than for a charity or for a qualifying disabled beneficiary). This means that, to the extent that the nil-rate band is not available, the gift will attract an immediate IHT charge of 20%, to rise to 40% if death follows within seven years. The big traditional non-tax advantage of gifts into trust is asset protection: any beneficiary will receive only by way of income or capital either what they are entitled to under the settlement or as the trustees determine, that is capital can be preserved in the unfortunate event of personal insolvency. Matrimonial breakdown is more difficult: a divorce court is not necessarily precluded from treating assets held within a trust as a financial resource of a divorcing beneficiary, in circumstances where the court considers that part of the trust fund is in reality being used (or will be used) for the benefit of that beneficiary although it will probably stop short of ordering the trustees to make a distribution to the beneficiary. There is a significant CGT advantage presented by hold-over relief as mentioned above. Hold-over relief can be claimed on a gift to an individual only where business assets are given away. The IHT reservation of benefit principles apply as with outright gifts. then the sky s the limit : the nil-rate band poses no issues because the chargeable value of the gift is (with 100% relief) reduced to nil. IHT efficiency within the trust will be maximised by ensuring that the property continues to attract relief for the trustees. This is for two purposes: On any charge which arises at a 10 year anniversary or on an exit of capital (a regime on which the Government is to launch a consultation to look at ways of simplification); and Under the claw-back rules, should the settlor of the asset die within seven years, to maintain relief on the original gift the trustees must have retained the original property (or qualifying replacement property) which still attract relief in their hands. Income Tax efficiency within the trust will be maximised by giving the beneficiaries a right to income, so that the trustees pay Income Tax at no more than 20%. Within a discretionary trust the trust rate is 42.5% for dividend income and otherwise 50% (37.5% and 45% respectively from 2013/14), subject to the 20% standard rate band for the first 1,000 of income. It may be possible for a non-taxpaying beneficiary to recover tax paid by the trustees though not the 10% nonrepayable dividend tax credit. And, indeed, if the subject-matter of the gift attracts agricultural or business property relief, Page 7 of 9

8 Conclusion This is a very brief rundown of the taxation considerations of lifetime giving, largely IHT. Should you wish to explore the topic further in your own circumstances, we shall be more than happy to discuss this with you. You should remember that this is a subject which should be kept under regular review, in conjunction with your Will planning, say every five years or (if sooner) on any significant changes in your family circumstances, in your assets on indeed in the applicable tax law. For further information, please contact the head of the department : Hugh MacDougald DT: E: hmacdougald@wslaw.co.uk Page 8 of 9

9 Appendix : Your Estate for IHT purposes Assets /Self /Spouse/Civil Partner Main Residence, Other Houses, Flats etc (net of mortgage). Personal Chattels. Investments. Bank and Building Society Accounts. Agricultural/Business Property (after 50%/100% relief). Value of Qualifying Interest in Possession Trusts. Loans made to other people. Assets in which you have reserved a benefit. Life Assurance Policies not written in trust. Other Assets. Less any Liabilities ( ) ( ) Chargeable total Page 9 of 9