Trusts and CGT

A trust is an obligation that binds a trustee, an individual or a company to deal with the assets such as land, money and shares which form part of the trust. The person who places assets into a trust is known as a settlor and the trust benefits one or more beneficiaries.

The trustees make decisions about how the assets in the trust are to be managed, transferred or held back for the future use of the beneficiaries. They are also responsible for reporting and paying tax on behalf of the trust. A trust needs to be registered with HMRC if it pays or owes tax. CGT may be payable when assets are placed into or taken out of a trust.

If assets are transferred into a trust, then tax is paid by either the person selling the asset to the trust or the person transferring the asset (the 'settlor').

If assets are taken out of a trust, the trustees usually have to pay the tax if they sell or transfer assets on behalf of the beneficiary. However, the rules are complex and there are different types of trusts that need to be considered, such as bare trusts or non-UK resident trusts.

Most trusts have an annual exemption from CGT, currently £6,150 (2020-21). There is a higher limit of £12,300 if the beneficiary is vulnerable, a disabled person or a child whose parent has died.

IHT exemption for gifts out of income

It is possible for wealthier taxpayers to take advantage of the IHT exemption for gifts and payments that are paid as normal expenditure out of income. This is a very flexible exemption from IHT as there are no specific requirements, for example, making fixed, regular gifts to the same person. With proper planning this can be a particularly useful tool and could include helping grandparents pay school fees for their grandchildren.

However, careful consideration has to be given to ensure that these payments form part of the transferor’s normal expenditure and is made out of income and not out of capital. The person gifting the money must also ensure that they are left with enough money to maintain their normal standard of living. A gift must meet all of the conditions to qualify for the exemption and must not fall within any of the exceptions.

This relief is separate to the annual Inheritance Tax exemption of £3,000 for gifts. This exemption can also be carried forward to the following tax year if not used, to make a maximum gift of £6,000. Individuals can also give as many gifts of up to £250 per person as they want during the tax year but only if they have not used another exemption with the same person. There are also special allowances for gifts made at a wedding or civil ceremony.

10% reduction in Inheritance Tax rate

If your total assets exceed £325,000 then the excess will usually be subject to Inheritance Tax (IHT) at 40% when you die. A reduced rate of IHT of 36% applies where 10% or more of a deceased’s net estate is left to qualifying charities or Community Amateur Sports Clubs (CASCs).

The net value of an estate is the total value of its assets (gross value) after deducting the following:

  • Debts and liabilities
  • Inheritance tax reliefs
  • Exemptions such as assets left to a married or civil partner
  • All items below the current £325,000 IHT threshold.

If you are considering making a charitable legacy this can make the process very tax efficient and significantly reduce the 'cost' of your charitable donation. It can also be a worthwhile exercise to review your will and see if your estate will qualify for this relief, especially if you are at or near the 10% limit.

Remember, the 'net estate' value on which the 10% figure is based is after all relevant deductions. So, if the value of your net estate was £100,000, the estate would have to pay IHT of £40,000 (£100,000 x 40%). If a charitable legacy was left of £10,000, then the remaining chargeable assets in the estate of £90,000 would pay IHT of £32,400 (£90,000 x 36%). This represents a saving in IHT of £7,600.

It can sometimes be a complex procedure to ensure that an estate qualifies for the reduced rate of IHT. The value of certain charitable gifts (such as a piece of land) must be calculated to establish whether or not the 10% test is met. It is possible for an election to be made that the estate does not pay the reduced rate of IHT. This could happen where the administrative costs, such as valuing assets, outweigh the benefit of the reduced rate of tax.

IHT tenants in common or joint tenants?

As a general rule, Inheritance Tax (IHT) is collected from a person's estate when they die and can also be payable during a person’s lifetime on certain trusts and gifts. There is normally no tax to be paid if the value of the estate is below the IHT nil rate threshold of £325,000.

The remaining amount after deducting the nil rate band, main residence nil-rate band, IHT exemptions and reliefs is liable to IHT at 40%. A reduced rate of IHT of 36% applies where 10% or more of a deceased’s net estate is left to charity.

A surviving joint tenant automatically inherits anything that was owned as 'joint tenants'. Joint tenants hold equal shares of the property with the same deed. The surviving joint tenant can be liable to pay IHT if the deceased’s estate can’t or doesn’t pay.

The rules are similar for 'tenants in common'. The basic difference versus joint tenants is that tenants in common can have unequal shares and different ownership interests.  As with joint tenants, if the estate doesn’t have enough money to pay the IHT, the tenants in common will be liable.

The inheritor is also liable to pay tax on any profit they make from inherited cash or assets. For example, where a property is inherited and then rented – Income Tax would be due on the rental income (subject to the usual rules). Likewise, if assets are inherited and subsequently sold, Capital Gains Tax would be due on the increase in value since the person died.

Cash gifts this Christmas

We thought it would be useful to remind our readers of the IHT implications of making cash gifts this Christmas. You can give away up to £3,000 worth of gifts each tax year. This is known as your annual exemption. Any unused part of the annual exemption can be carried forward, but only for one year. So, if you didn’t make any cash gifts in 2018-19, you could gift up to £6,000 this year.

There are also generous exemptions for normal Christmas (or birthday) gifts made out of your income but you must be able to maintain your standard of living after making the gift. There are also reliefs available for wedding gifts. The amount of tax relief varies depending on the relationship between the donor and the recipient.

You can also give as many small gifts of up to £250 per person as you want during the tax year but only if you haven’t used another exemption on the same person. There is no Inheritance Tax to pay on lifetime gifts between you and your spouse or civil partner as long as you both live permanently in the UK. Other gifts, outside these parameters, count towards the value of your estate and should be carefully considered.

Giving away a home before death

The majority of gifts made during a person's life, including gifting away a home, are not subject to tax at the time of the gift. These lifetime transfers are known as 'potentially exempt transfers' or 'PETs'. These gifts or transfers achieve their potential of becoming exempt from Inheritance Tax if the taxpayer survives for more than seven years after making the gift. There is a tapered relief available if the donor dies between three and seven years after the gift is made.

HMRC’s guidance suggests that if the person gifting the home wants to continue living in the property after giving it away, they need to:

  • pay rent to the new owner at the going rate (for similar local rental properties)
  • pay their share of the bills
  • live there for at least 7 years

However, the rules are different if the person making the gift retains some 'enjoyment' of the gift made. This could apply if a person gave their house away to their children but continued to live in the home rent-free. Under these circumstances, the taxman would contend that the gift falls under the heading of a gift with reservation of benefit and the 'gift' would remain subject to Inheritance Tax even if the taxpayer dies more than 7 years after the transfer.

Inheritance Tax Agricultural Property Relief

There are a number of reliefs available that can reduce liability to IHT. The most relevant for farmers is the Agricultural Property Relief (APR). Relief is available at a rate of 100% or 50% depending on who farms the land and how long the land has been owned.

The APR can be claimed on assets including:

  • farming land or pasture that is used to grow crops or to rear animals intensively,
  • working farmhouses,
  • farm workers’ cottages, barns and stud farms. 

There is no agricultural relief for farm equipment, but the equipment itself may qualify for another relief known as business relief.

The APR is available for working farms in the UK, Channel Islands, the Isle of Man or the European Economic area. It is important to note that the relief is based on the agricultural value of the land. For example, a farmhouse is valued as if it could only be used for agricultural purposes rather than open market value. The valuations of farmhouses in particular is often the subject of debate.

It is important to ensure that any claim for APR is realistic as HMRC’s refusal to accept an APR claim could result in a significant amount of IHT being due together with the possibility of penalties being levied. There can also be issues where the farming business has diversified into non-farming activities such as wind farms, holiday lettings and farm shops.

When Inheritance Tax applies to pensions

Inheritance Tax (IHT) is levied on a person’s estate when they die and can also be payable during a person’s lifetime on certain trusts and gifts. The rate of Inheritance Tax payable is 40% on death and 20% on lifetime gifts. There is a nil-rate band, currently £325,000 below which no Inheritance Tax is payable.

A pension is normally free of IHT and unlike many other investments is not counted as part of a deceased persons taxable estate. However, any money taken out of a pension before death becomes part of the deceased estate and could be subject to IHT. This includes any tax-free cash allowance which might not have been spent.

IHT charges relating to pensions can arise in relation to the following:

  • Lifetime transfers
  • Benefits within the estate
  • General power over benefits
  • Omission to exercise a right
  • Alternatively secured pensions

 

Life policies and Inheritance Tax

A life policy is a contract with an insurance company. In exchange for premium payments the insurance company provides a lump-sum payment to beneficiaries if the policy holder dies during the terms of their policy. There are various types of life policies available. The main types are 'term', typically covering a set period of time or 'whole of life', meaning that they are active until death.

The policies are often used as Inheritance Tax mitigation and avoidance devices. HMRC is clear that where a person transfers a policy to another, its value at the date of transfer may be taxable as a gift. If a person takes out a policy for the benefit of another person, the cost of effecting the policy will also be taxable as a gift. Similarly, if they pay the premium on a policy owned by somebody else, the amount of the premium considering any exemption due may be a Potentially Exempt Transfer or a chargeable transfer.

When the life assured dies, the proceeds of the policy will be payable to the person who owns the policy or to some other person specified under its terms. In cases where the beneficial owner of a life policy dies before the life assured, there will be a transfer on their death of the life policy with the other assets in the estate.

Gifts in anticipation of marriage

There is a special exemption from Inheritance Tax for cash gifts made on or shortly before the date that the relevant wedding or civil partnership ceremony takes place.

The amount of tax relief varies depending on the relationship between the donor and the recipient.

  • Each parent (including step-parents) can gift up to £5,000 tax free
  • Grandparents and Great grandparents can each gift up to £2,500
  • Any other person can each gift up to £1,000

If the value transferred by the gift is more than the amount of the available exemption, it is an exempt transfer up to the amount of the available exemption, and the excess is chargeable.

There is also a separate, general annual exemption of £3,000 for gifts. This exemption can be carried forward if not used to make a maximum gift of £6,000. These gifts are ignored in the event of the donor’s demise within 7 years of making the gift.

There are also exemptions for normal gifts out of income such as making birthday gifts. A donor can also give as many gifts of up to £250 per person as they want during the tax year but only if they haven’t used another exemption on the same person.

Newly married couples should be advised that there is no IHT to pay on lifetime gifts between spouses or civil partners as long as they live together in the UK.