ACCA ATX ^UK Syllabus A2. Chargeable gains - Capital gains tax planning - Notes ^{5 / 5}

How to plan to minimise the capital gains tax liability?

Gifting or selling assets has 2 results for tax - inheritance tax and capital gains tax, therefore the choice to gift must be made carefully, in order to avoid both taxes!

Example

A owns 100% of the shares in A Ltd an unquoted trading company. 

A Ltd has 100,000 £1 ordinary shares in issue all of which were subscribed for at par by A in 2005, from which date A has been the managing director of the company.

Share valuations have now been agreed as follows:
20% £10 per share
40% £15 per share 
80% £20 per share 
100% £25 per share

What are the tax implications of gifting 20,000 of his shares to his daughter?

Inheritance tax implications

For IHT purposes the gift would be a potentially exempt transfer (PET) and have no immediate tax implications. 

If A died within 7 years of the transfer the PET would become chargeable at either nil rate and / or 40% rate depending upon what other transfers had been made by A prior to this gift. 

If A survived for at least 3 years then any IHT computed would be reduced by taper relief. 

Any such IHT payable would be payable by the donee, V and should be paid within 6 months of the end of the month in which the death occurred.

The value of the PET would be the fall in value of the estate of A.
Before the gift 100,000 shares @ £25ps      £2,500,000
After the gift 80,000 shares @ £20ps         £(1,600,000)
Transfer of value                                           £900,000

Capital gains tax implications

The shares are £1 ordinary shares which were subscribed for at par, so the cost is £1 per share.

The gain that arises would be included in the net gains of the tax year from which the annual exempt amount would be deducted to derive the taxable gain. 

The question then arises as to what tax rate would apply? 

Shares in unquoted trading companies are a qualifying business asset for purposes of entrepreneurs’ relief/business asset disposal relief and as A owns the minimum required 5% shareholding and is an employee of the company, a claim for entrepreneurs’ relief/business asset disposal relief is available and will result in a 10% tax rate being applied to the taxable amount of the gain.

There is however another RELIEF that is available where such an asset is gifted! 

Yes gift relief is available to be claimed, jointly by A and V, as shares in an unquoted trading company are qualifying business assets for gift relief purposes.

This would allow the entire gain to be deferred, such that the donor, A, would not now be chargeable and the daughter, V would be deemed to acquire the shares at the original cost to the father of £20,000 instead of a cost of £200,000.

Without gift relief the shares are deemed to be acquired by V at their open market value of £200,000. With gift relief, that cost is reduced by the amount of the deferred gain (£180,000) and thus a cost to V of £20,000 would then apply.

NOTICE how the value for IHT and CGT are different.  For CGT you value the asset that is given away, eg a 20% shareholding.  For IHT you look at how much the gift reduces the donor’s estate by. In this case it reduced it from a 100% holding of shares to an 80% holding of shares.

Conclusion

For those taxpayers with both a capacity and a willingness to make gifts in lifetime and not just on death, the further guidance that they may request from you is whether to make such gifts in lifetime or wait and gift the assets upon their death. 

It is again a consideration of the capital taxes that is the key issue.

If assets are gifted on death there will be no CGT and the beneficiaries will acquire those assets at their then value, thus wiping out any accrued gains on those assets. 

The assets, however at their then open market value (probate value) will then be included within the chargeable estate at death, which being in excess of the available nil rate band will be charged to IHT at a rate of 40%.

Therefore to avoid IHT it would be better to gift in lifetime as when a PET is made there is no immediate charge to IHT and the PET will only become chargeable if the donor dies within 7 years. 

The further advantages for IHT of gifting in lifetime are that if the taxpayer at least survives for 3 years then taper relief will reduce any IHT payable, plus the value of the PET is “frozen” at the date of the transfer meaning that an appreciating asset will have a lower value charged to IHT than if it had been kept until death. 

Lifetime gifts will also benefit from annual exemptions.

The problem of course with gifting in lifetime as we have already seen is CGT, as a gift in lifetime is a chargeable disposal and a gain must be computed using the open market value of the asset. 

This, however will only happen if the asset is a chargeable asset so that exempt assets such as cash, chattels and cars could be gifted without any CGT arising.

If assets are chargeable assets then they may still be gifted if the gains arising each tax year do not exceed the AEA, for example if the taxpayer gifts an asset valued at £50,000 and it cost £47,000, there will be a chargeable gain of £3,000 which will be covered by the AEA of the taxpayer. 

This will have removed £50,000 of value from the taxpayer’s estate which at death may have been charged to 40% IHT.

If chargeable assets will give rise to more substantial gains then as we have seen above, if the asset is a qualifying asset for gift relief then the gain may be deferred by a claim for gift relief. 

If the asset was the principal private residence of the taxpayer then PPR relief would be available to exempt any gain arising but there could be a potential IHT charge if the Gifts with Reservation of Benefits rules apply (see later Topic).

You should keep all of these things in mind for written sections in the exam!