Estate planning and gifting shares to children and grandchildren

When considering estate planning, it is important to remember that assets are valued differently for the purposes of Inheritance Tax (IHT) and Capital Gains Tax (CGT). The loss to the donor principle and related property rules apply to IHT, whereas neither of these is relevant for CGT. As a result, the value of a gift for IHT purposes can be much higher than the value of that same gift for CGT purposes.

This gives scope for estate planning as the potential IHT saving can be much higher than the CGT cost of achieving that saving. This will usually be the case where the same assets are held by spouses or civil partners and, if so, the order in which gifts are made can have a significant impact on the ultimate tax savings.

Tax planning opportunities

Martin and Frances want to reduce their IHT estates by gifting shares in Propco to James and Jane and then hopefully surviving seven years.

Inheritance Tax

Assets held by spouses are treated as related property for the purposes of IHT valuation.  This means that the value of the shares held by Martin and Frances is 50% of a 75% valuation of Propco.

75% of Propco is valued at £1,350,000 (10% minority discount) and the value of the shares held by Martin and Frances for IHT purposes is therefore £675,000 each, not £450,000 each.

Capital Gains Tax

A gift of shares by Martin or Frances is a disposal for CGT purposes but the related property rule does not apply when valuing the shares gifted, as there is no equivalent in the CGT legislation.

Order of gifting

As Martin is more than 10 years older than Frances, it might be thought that he should gift his shares to Frances (IHT exempt) and Frances should then make a gift to the children, as she is more likely to survive seven years.

The best course of action, however, is for Martin to retain his shares and for Frances to gift her shares to the children.

If Frances gifts her entire 37.5% shareholding, she would make a potentially exempt transfer (PET) for IHT purposes of £675,000 and a disposal for CGT purposes of £450,000. In addition, the value of the shares held by Martin would be reduced by £225,000 to £450,000 as the related property rules would no longer apply. The total IHT reduction would therefore be £900,000.

Should Frances die within seven years of making the gift, the PET of £675,000 would fail and IHT would become payable, although taper relief would be available if she died after more than three years. The CGT payable on disposal would be £108,000 (£450,000 @ 24%).

The IHT reduction of £900,000 would therefore achieve a potential IHT saving at 40% of £360,000 at a CGT cost of £108,000. The PET made by Frances to achieve the IHT reduction of £900,000, however, would only be £675,000.

As Martin is likely to predecease Frances, he could leave his 37.5% shareholding to her on death under the terms of his Will. On Martin’s death, she would enjoy a tax-free uplift in the value of his Propco shares for IHT purposes, which she could then gift free of CGT to James and Jane, if she so wished.

Although the same IHT reduction of £900,000 at a CGT cost of £108,000 would be achieved if Martin gifted his shares to Frances who then gifted them to their children, the PET made by Frances would be £900,000 not £675,000. Therefore, if she died within seven years, IHT would become payable on a PET of £900,000 rather than on a PET of £675,000.

Additionally, for CGT purposes, there would be no tax-free uplift to market value of the shares gifted by Martin to Frances, as they would be deemed to be transferred for such consideration as results in nil gain/nil loss.

Associated Operations rule

Associated operations regulations exist to stop IHT avoidance through dividing one transfer into multiple transactions to minimise IHT liability.

HMRC accept that where property given unconditionally by one spouse to the other is subsequently transferred by the latter to a third party, the Associated Operations rules cannot be used to attribute the transfer to the first spouse, unless the inter-spouse transfer is part of a more complex series of transactions which taken together are the way one of them makes a disposition to a third party.

What Next?

IHT is complex legislation, and the conditions for relief must be observed very carefully. To find out more about useful planning opportunities that could increase the level of IHT relief, get in touch with our experts here at Gravita.

If you are thinking about the future, view our Succession hub for more information.