Is a property transfer before a discounted gift trust beneficial tax planning? BKL tax adviser Terry Jordan has answered this query for Taxation magazine’s readers’ forum.
My client lives in a house worth about £700,000. He also owns an investment company that holds investments under management of about £900,000. The investment manager has suggested to my client that he might like to consider a discounted gift trust but he does not have any cash.
Would it be possible for him to sell his house to the company for £700,000 and place the investment, which would now be in his name, into a discounted gift trust? He could then draw 5% from the discounted gift trust each year to provide him with an income. At present, he must draw income from the company and either pay PAYE tax on this or the new dividend tax. The intention is to transfer the shares in the company to his children over time using his and his wife’s capital gains tax annual exemption.
If he lives long enough, the balance on the discounted gift trust would pass to his beneficiaries without inheritance tax and his children would already own the shares. In fact, ignoring all other assets, he would probably need only to transfer enough shares to reduce the value of his and his wife’s equity to £650,000 to claim their inheritance tax exemption.
One other point is that I presume he and his wife would need to resign as directors of the company because, otherwise, they would be living in a property owned by the company. Presumably, it would not matter that he pays no rent to live in the property and it does not matter that he and his wife will be participators, but not directors.
Would this scheme would work in practice?
Query 19,064– Button.
Reply by Terry ‘Lacuna’ Jordan, BKL
I think this otherwise cunning plan might have some flaws.
The sale will incur a liability to stamp duty land tax (SDLT) at the top rate of 15%. (Relief will not be available because the property will be an ‘enveloped’investment as below.) For the company to be able to provide the cash apparently it will need to dispose of some of its investments which will potentially lead to a liability to corporation tax on any gains.
Because the property is worth more than £500,000, the company will be liable to the annual tax on enveloped dwellings (ATED) with a current annual liability of £3,500.
I assume that no chargeable gain would arise on the sale of the property on the premise that it has been the client’s only or main residence throughout his period of ownership, but within the company it would not benefit from that relief nor would it enjoy an uplift to market value if the client dies. In fact the company would potentially be liable to ATED-related capital gains tax on a future disposal.
Although it is proposed that the client and his wife resign as directors, they are likely to be regarded as ‘shadow directors’ and liable to tax on benefits in kind: see for example R v Allen [2001] UKHL 45 heard in the House of Lords.
The sale for full consideration to the company would not of itself be a gift with reservation of benefit, but if the client starts to gift the shares it is a moot point as to whether those gifts might be caught.
By transferring the property to the company, the client may miss out on the inheritance tax residence nil-rate band unless he retains assets of equivalent value.
Given that, by 6 April 2020, the client and his wife would have combined ordinary and residence nil-rate bands amounting to £1m, a more attractive alternative may be to retain the property and reduce the holdings in the investment company. On the premise that the children are over 18, a trust for their benefit could be used as a conduit to transfer shares to them with no immediate inheritance tax or capital gains tax cost as long as the client and his wife did not exceed their respective ordinary nil-rate bands.
