Individuals may consider giving away valuable assets to family members for various personal reasons, but one of the most logical reasons (at least, for UK domiciled and deemed domiciled individuals) is that doing so reduces the value of an individual's assets that are subject to taxation when they die, and reducing that charge to inheritance tax means more to give to chosen beneficiaries. The timing and mechanism of making gifts may be impacted by the nature of the asset and the individuals in question, but also the commercial circumstances.
Depressed asset values could be a good reason to triggering (less) tax now
Right now, the stock market turmoil in the wake of the spread of COVID-19 has, for some individuals provided new impetus for making gifts of assets whose values have significantly fallen
From an inheritance tax (IHT) perspective, when a gift is made during a person's lifetime there will be no IHT providing the donor survives the gift by seven years. If the donor does not survive the full seven years the rate of IHT is tapered down from 40%, which is applied to the value of asset at the date the gift was made. Therefore, making a gift now would firstly start the seven year clock running sooner. Second, it should “bank” a lower value of the gifted asset on which IHT would apply in the event of the donor's untimely death within the seven year period and in relation to which a lower level of life insurance cover could be purchased for funding the IHT in such unfortunate event.
Where a gift of an asset (or a sale) might usually have realised gains subject to capital gains tax (CGT) at a rate up to 20% (or 28% in the case of residential real estate or carried interests) a depressed value at the date of the gift or transfer means fewer gains being realised and so less for the CGT to bite on. Some assets may be standing at a loss. A capital loss in any one tax year can generally be carried forward to use it in subsequent years. Losses will be offset against current year capital gains first, and future year gains after that. By triggering losses now, these could be offset in the future against gains which are likely to be taxed at a higher rate than the current 20%.
The spectre of future tax increases
There is another reason for considering making gifts now. The Government has responded to the spread of COVID-19 with a raft of financial packages to support individuals and businesses. The reality of paying for this financial support brings with it the spectre of tax rate increases, notwithstanding the pledges made in the Tory manifesto written without any contemplation of this unprecedented event.
It would not be unreasonable to expect an increase in CGT; and even before the advent of the pandemic, the Government was looking at ways to overhaul elements of the IHT regime. Certainly the latter had already brought into sharper focus the need to consider lifetime gifting sooner rather than later in case the ability to make gifts free of IHT might be restricted.
But, I would worry whether the recipient of my gift is at the right age and stage to receive such a valuable asset
Many of our clients have established what are known as 'Family Limited Partnerships', effectively vehicles which allow family members to make gifts to the younger generation. They are particularly useful for clients who are UK resident and domiciled who generally cannot set up trust structures. The benefit of structuring using a FLP is they allow gifts to be made whilst ensuring that younger family members do not receive too much, too soon.
Gifting assets into a trust during lifetime is another option. The current market conditions could present an opportunity for funding a trust in a tax efficient manner because the value of the assets being contributed has fallen (so reducing any tax to fund the trust).
But, remember, in tax and practical terms this is not the same as making an outright gift. A trust will certainly provide asset protection as the trustees will effectively determine how and when the beneficiaries benefit. But, for UK resident and domiciled individuals, as well as those who are treated as 'deemed domiciled' in the UK for all tax purposes, transferring assets valued at more than £325,000 (the present inheritance tax ‘nil rate band' amount) into a trust, will usually trigger a 20% IHT. That said, since every individual has their own ‘nil rate band' amount, a couple could jointly transfer £650,000 to a trust without triggering IHT. Also, exemptions and reliefs are available in respect of certain assets, for example, certain types of businesses or AIM listed shares (for now).
If individual have valuable assets which they would contemplate passing on to family members (or even others), doing so whilst valuations are depressed and ahead of any gift tax which could be introduced, is a sensible step to manage both the IHT which might be due, and CGT which would have generally have been triggered when valuations were higher. The choice of mechanism should, however, be carefully considered in light of the assets and circumstances of individuals involved, and costs to achieve asset protection, if that is desired. Finally, when making a gift, you should only ever give away what you can afford to – it is not advisable to make large gifts if this will result in you struggling financially as a result.
Originally published by Withersworldwide, April 2020
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.