Author | Lianne Lodge of Gillespie Macandrew | June 2015
We all recognise that making gifts can be a crucial and an incredibly useful strategy in tax planning while also allowing the giver to bask in the enjoyment their gift has allowed and hopefully enjoy a feel good factor. However, before we all merrily begin to give our assets and live like paupers, there are a few dangers or pitfalls which should be considered which, if you fall foul of them, can either undermine the tax efficiency of the gift or possibly lead to other potentially unforeseen tax liabilities. Below are a few dangers to look out for. This is not intended to be an exhaustive list and proper advice should be taken at the time of considering your gift.
Power of Attorney
If you are making gifts while acting as an attorney, remember that there must be the specific power in the deed to (a) make gifts; and (b) make them for tax planning reasons. Without such powers the gift would be (without power (a)) invalid and (without power (b)) challenged by the Revenue when looking at the assets owned for Inheritance Tax purposes. Remember that the Revenue asks for a copy of the Power of Attorney after a person has died for a reason!
Even if you can overcome these hurdles you must bear in mind the principles of the Adults with Incapacity (Scotland) Act 2000 and specifically show benefit to the adult and that the gifts are in line with his or her past and present wishes.
Gift with the Reservation of Benefit and Pre-owned Assets
The first of these is self-explanatory to a degree. If you make a gift you must actually make it and alienate the object from yourself. The classic examples stand: If you give a painting, it cannot hang on your wall anymore and if you give a house you cannot continue to live in it. If you did either the Revenue will assume that you still own that asset when calculating the Inheritance Tax due, even if it was given more than 7 years ago. Pre-owned Asset Tax is a little more complex and looks to ensure that you are not deriving a benefit from an asset which you previously owned and over which there is no Reservation of Benefit, even if the form of the gift has changed. A classic example is that father gives son £200,000. Son then uses cash to help to buy a house in his own name which he moves in to. Father then also moves in. This could be caught by the pre-owned asset rules.
However, there are ways in which you can still have your cake and eat it, either through a rental scheme whereby you pay a market rent for the retained gift or tax under the Pre-owned Asset legislation. In certain circumstances, an arrangement whereby a capitalised rental arrangement can be put in place could also be an attractive option. But even these can be fraught with pitfalls for the uninitiated and you will need both professional legal/tax advice as well as professional valuations, and for the capitalised rental arrangement, you may well need the input of an actuary or surveyor too. Remember also that the rent paid should be reviewed regularly and will increase (or decrease) with current market conditions.
Capital Gains Tax
If you are giving an item rather than cash then the Revenue will treat any gift as a disposal at open market value. This is the case even if no money changes hands or if a reduced price is paid. That means that the value of any gain (from the date you owned it to the date that it was given subject to any allowable expenses) could be liable to Capital Gains Tax. There are a few exemptions, notably those known as “wasting assets” which are items with a predicted life of 50 years or less provided they are not eligible for any business allowance. This also includes antique clocks, vintage cars, pleasure boats and caravans.
There are other exemptions for chattels which are items with an expected life of over 50 years. These are:
- where bought and sold for less than £6,000 there are no CGT consequences and the gain or loss would be exempt
- if the item cost more than £6,000 and is sold for less then the disposable proceeds would be deemed to be £6,000 less any cost of sale.
- if the item was sold for more than £6,000 but bought for less then special rules apply providing tax relief for any assets sold for less than £15,000.
It is therefore important to ensure that you have professional valuations before making any gift. This can make negotiations with the Revenue at a later date much easier and put your executors and/or beneficiaries in a stronger position to argue any valuation case.
Giving part of a set
If you own a set and give the entire thing away then the above CGT rules would apply and the set is treated as one item. If, however, you give part of a set then you have to be very careful in terms of the loss of value to your estate. Imagine that you have a pair of matching candlesticks worth £50,000. You give one candlestick away and that one candlestick on its own is worth £15,000. You still own the remaining candlestick worth £15,000. The loss to your estate is, in this case £35,000 as you had an asset worth £50,000 before and £15,000 after you made the gift and worth. This is then the value of the gift for Inheritance Tax purposes rather than the £15,000 asset received by the recipient of the gift. Again this shows how important it is to get valuations both of the items given and of the set itself to allow you to make the decision as to the best course of action.
Taper Relief is available to reduce the IHT payable on gifts made three to seven years before death. It is a common misconception that taper relief reduces the value of the gift which is not the case, it is the tax that is reduced not the value of the gift itself. For example, say the gift was made six years and 10 months before death, you would work out the tax due on the gift (i.e. deduct any allowable annual exemptions and Nil Rate Band) and the balance would be charged at 40%. You would then be allowed a relief at the rate of 80% on the IHT due and only pay 20% of the tax due. You should also remember to look at any tax paid during your lifetime if the gift was a chargeable lifetime transfer (generally gifts into Trust) rather than a potentially exempt transfer (generally gifts to individuals).
It is important to note that the effect of Taper Relief is to reduce the IHT payable. If the gift was below the Nil Rate Band available at the time of death then there would be no tax due and therefore no relief available. The Nil Rate Band is the amount that you are allowed to give away tax free on your death and is currently £325,000. You may also benefit from a Transferable Nil Rate Band which may be available if you are a widow or widower and your spouse did not use their available Nil Rate Band at the time of their death.
Annual gift exemptions, etc.
Clients should be made aware of and encouraged to take advantage of the annual gift exemption of up to £3,000 each year and which, if not used in one year, can be rolled forward to the following year, lifting the value to £6,000. There are also opportunities for giving on the occasions of weddings and civil partnerships for tax efficient giving by parents (£5000), grandparents (£2500) or anyone else (£1000). The value of chattel gifts is considered to be at open market value. This can be particularly important when calculating the value of jewellery where there can be a huge markup on the retail (and hence insurance) value. Again, having a professional valuation, which need not be expensive in relation to the total value of the gift, could be useful not only to the giver but also to the recipient and should help avoid any future comeback by HMRC.
Habitual gifts out of excess income is another useful exemption which can allow you to remove substantial funds from your estate if the circumstances allow. The Revenue look very closely at this relief and therefore advice should be taken beforehand and proper records kept to ensure that your executors have all the ammunition they may require to fend off any enquiries after death.
The main point to note is that professional advice should be taken before making any gift as it can lead to some, often unforeseen circumstances, which can sour the gift in the long run. It’s perhaps also useful to note that the various tax issues relating to giving are still reserved to the UK Parliament and have not been devolved, as yet, to the Scottish Government.