Writing for Taxation magazine, BKL tax partner Terry Jordan explores the use of a trust to transfer assets pregnant with capital gain to younger generations free of any immediate tax charges using the givers’ IHT nil rate bands and a trust structure.
Will passing shares through a discretionary trust avoid a capital gains tax charge?
A client and his wife own shares in a property investment company and would like to start gifting shares to their adult children as the first stage in their inheritance tax mitigation strategy.
The difficulty is that the value of the properties has risen significantly since they were originally acquired by the company so a considerable capital gain would trigger were they to simply gift the shares.
We are aware that the gift of an asset into a discretionary trust is immediately chargeable to inheritance tax and, as long as the trust is not settlor-interested, holdover relief should be available in relation to the resulting capital gain under TCGA 1992, s 260.
A thought, therefore, would be for the couple to transfer shares up to the value of the inheritance tax nil-rate band into a discretionary trust for their adult children’s benefit. This would at least take £650,000 of value out of their estate, without crystallising capital gains.
The couple have no issue with their adult children owning the shares outright; the trust would simply be used as a mechanism to avoid an immediate capital gains tax charge. Further, there seems no difficulty with a trust continuing to hold the shares and distribute dividends, apart from the associated administrative costs.
However, it has been suggested that after, say, one year the shares could be distributed out of the trust to the adult children, with holdover relief being claimed again. The trust would then be wound up.
Would passing an investment asset through a trust in this way be an effective method of avoiding the capital gain that would arise if the assets were simply gifted outright, straight from the parents to the adult children?
Assuming that there may be a catch in the above plan, are there other ways to mitigate the inheritance tax exposure on these shares?
Query 18,544 – Property Man
Reply from Terry “Lacuna” Jordan, BKL
The writer remembers the abolition of the general holdover relief for capital gains tax in the late 1980s. After the introduction of inheritance tax in 1986, the rationale was that most lifetime transfers were potentially exempt and it was less likely that charges to both inheritance tax and capital gains tax would arise on the same occasion.
Holdover relief was preserved for transfers that are immediately chargeable for inheritance tax purposes and, after political lobbying, for exits from old-style accumulation and maintenance trusts; however, this was only where the beneficiary had not previously taken a right to income.
As Property Man is aware, for holdover relief to be available on a transfer to a trust, the settlor, his spouse or civil partner and any minor children must be excluded from benefit.
Reference is made to a discretionary trust but, since 22 March 2006, almost all lifetime transfers to trust have been immediately chargeable for inheritance tax purposes. Accordingly, an interest in possession trust for the benefit of the client’s adult children would afford holdover relief and would avoid the potential income tax downside of dividends arising in a discretionary trust.
After an absolute minimum period of three months – before which no inheritance tax charge would arise – the shares could be appointed out to the children with holdover relief being claimed jointly by them and the trustees (on transfer to trust the relief is claimed only by the settlor).
Alternatively, the shares might remain in trust at least for the first 10 years and would not form part of any individual’s inheritance tax “estate”. This might also afford a measure of protection if one of the children divorce.
The clients could repeat the process in seven years when they would regain their nil-rate bands.
Finally, although reference is made to £650,000 worth of shares being settled, it is the loss to the transferors’ estates that determines the value transferred for inheritance tax purposes and it is often the case that the value of the shares settled in such circumstances is less than £650,000.