King, a wealthy client of your firm with a significant property portfolio, requires advice on the sale of some unquoted shares and on the capital gains tax and inheritance tax implications of transferring assets to a trust and to his two children.

King:
– Is resident and domiciled in the UK.
– Is an additional rate taxpayer.
– Has used his capital gains tax annual exempt amount for the tax year 2015/16.
– Has made one previous lifetime gift of £25,000 to his daughter, Florentyna, on 1 June 2014.
– It should be assumed that King will die on 1 May 2017.

King’s family:
– King’s daughter, Florentyna, is 34 years old and has two young children.
– Florentyna will have income from part-time employment of £10,000 in the tax year 2015/16. This is her only source of taxable income.
– King’s son, Axel, is 40 years old and has an 18-year-old daughter, who is a university student.

King’s plans:
– On 1 September 2015, King will sell some of his shares in Wye Ltd.
– On 1 October 2015, King will put a cottage he owns in Newtown and the after-tax cash proceeds from the sale of the shares in Wye Ltd into an interest in possession trust for Florentyna and her children.
– On 1 March 2016, King will gift his share of a flat in Unicity to Axel.

Sale of shares in Wye Ltd:
– Wye Ltd is an unquoted investment company.
– King acquired 5,000 shares in Wye Ltd on 1 June 2002 at a cost of £5 each.
– These shares will be worth £45 each on 1 September 2015.
– King will sell sufficient shares to generate after-tax proceeds of £30,000.

Cottage in Newtown:
– This property is wholly owned by King.
– It is expected to have a value of £315,000 on 1 October 2015.

Creation of the interest in possession trust:
– King will pay any inheritance tax arising as a result of the gifts made to the trust.
– Florentyna will be the life tenant and her two young children will be the remaindermen of the trust.
– Florentyna will live in the cottage in Newtown and the trustees will invest the cash in quoted shares which will generate annual dividends of £3,000.

Flat in Unicity:
– The flat in Unicity is jointly owned by King and his wife, Joy, in the proportions: King 75% and Joy 25%.
– King and Joy have recently signed a contract with Axel’s daughter to rent the flat to her for three years starting on 1 September 2015.
– The rental agreement is on a commercial basis.
– King has obtained the following expected valuations for the flat as at 1 March 2016:

Required:
(c) Explain, with the aid of supporting calculations, why the disposal of the flat in Unicity may be caught by the associated operations rules and the increase in the inheritance tax liability which would arise on King’s death on 1 May 2017 if these rules were to apply. (7 marks)