TXF6 UK
Syllabus D. Inheritance Tax D1. Basic principles of computing transfers of value

D1c. Diminution in value principle

Syllabus D1c)

Demonstrate the diminution in value principle

Transfers of value may need to be calculated using the diminution in value principle

Ordinary shares in unquoted company as a GIFT

Normally, as seen in Topic Transfer of value, Chargeable Transfer, Potentially Exempt Transfer for most assets the transfer of value will be the same as the open market value of the asset 

e.g. gifting a property worth £250,000 or cash of £100,000, but for some assets, notably shares in unquoted companies the transfer of value may be considerably higher than the market value of the asset being gifted.

The transfer of value will be calculated as the difference in estate value before and after the gift of the asset.

Illustration:

A owns 60% of the shares in A Ltd. A Ltd has 100,000 £1 ordinary shares in issue.

Share valuations have been agreed as follows:

20% £10 per share
40% £15 per share
60% £25 per share
80% £40 per share

Required:

Compute the transfer of value if A were to die leaving his shares to his daughter, or alternatively if he were to make a lifetime gift of 20,000 shares to his daughter.

Solution:

  • If A died owning his 60,000 shares, a 60% shareholding, they would be valued at £25 per share i.e. 60,000 @ £25 = £1,500,000.

  • If, however, he were to give 20,000 shares in lifetime the transfer of value would not be based on the value of a 20% interest i.e. £10 per share, but would be computed as the difference between the value of his estate before and after the transfer:

Before 60,000 shares (60%) @ £25 = 1,500,000
After 40,000 shares (40%) @ £15 = 600,000
Transfer of Value 900,000

A transfer of value will arise by the gift of an asset either in lifetime and / or on death.

For most taxpayers, as stated above, their only transfers of value will arise as a result of their death.

Illustration:

B owns 80% of the shares in B Ltd. A Ltd has 100,000 £1 ordinary shares in issue.

Share valuations have been agreed as follows:

20% @ £10/share
40% @ £15/share
60% @ £25/share
80% @ £40/share

Compute the transfer of value and IHT payable if B were to die 2 years after leaving 20,000 shares to his daughter. 

All exemptions and Nil Rate Band have been used up.

Solution:

If A died owning his 80,000 shares, a 80% shareholding, they would be valued at £40 per share i.e. 80,000 @ £40 = £3,200,000.

If, however, he were to give 20,000 shares in lifetime the transfer of value would not be based on the value of a 20% interest i.e. £10 per share, but would be computed as the difference between the value of his estate before and after the transfer:

Before 80,000 shares * £40 = £3,200,000
After transfer 60,000 shares * £25 = £1,500,000

Value of PET
£3,200,000 - £1,500,000 = £1,700,000

IHT payable £1,700,000 * 40% = £680,000