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Avoiding IHT & CGT

UK Inheritance & Capital Gains Taxes

The SCF inheritance and capital gains tax mitigation department is headed by Andrew James Dalziel MA (Oxon), FCA, Chartered Accountant. In the case of both these specific taxes there are far more variables than for most other taxes, which is why specialist advice is almost always required. Factors that should be considered, especially for international clients, would include domicile and shares held in offshore and/or international companies and not only the general domestic tax mitigation techniques.

How to mitigate UK Inheritance Tax

As at the time of writing inheritances of up to £325,000.00 are tax free with any excess balance for UK residents being subject to a rate of 40% save where 10% or more of any given estate has been left to charity whereupon the rate is reduced to 36%. The result is that even relatively modest estates can incur significant IHT exposure even where the inheritor is a spouse – For example, if spouse 'A' pre-deceased spouse 'B' and left an estate of £3 million then even if both tax free sums applied, namely £650,000.00, that would still leave £2.4 million subject to a 40% tax or £960,000.00. This example shows why it is vital to seek professional advice and plan well in advance.

Common methods used to mitigate IHT

Lifetime Gifts for Family Members – the 7 Year Rule

This is perhaps the best know IHT mitigation method and is normally totally tax free provided the gift is irrevocable and made to a family member at least 7 years before the death of the donor. If the donor dies within the 7 year period the following applies, namely:

(a) If the gift was made less than three years before death, full IHT must be paid;

(b) If the gift was made three to four years before death, tax is reduced by 20%;

(c) If the gift was made four to five years before death, tax is reduced by 40%;

(d) If the gift was made five to six years before death, tax is reduced by 60%;

(e) If the gift was made six to seven years before death, tax is reduced by 80%;

Potentially Exempt Assets (PET's) – Some Examples

(a) Agricultural land or the proportion of value that can genuinely be deemed agricultural;

(b) Business transfers by sole proprietors and/or some partnerships provided the business is an existing business more than two years old and does not relate to businesses' in the property, securities or investment categories or certain share transfers;

(c) Deathbed investments of liquid assets – A relatively clever way to avoid IHT is by taking any personal liquid assets and re-investing them in a tax exempted business venture, which only need to be done 2 and not 7 years prior to death;

(d) Pension and Insurance contributions;

(e) Private limited company share restructuring – It is possible to avoid IHT by creating a second type of share category whereby profits and future growth are separated from the 'frozen' current share value enabling with appropriate drafting a potential nil IHT tax event;

(f) UK domiciled spouse to spouse gifts are generally free of IHT;

How to mitigate UK Capital Gains Tax

Capital Gains Tax (CGT) has existed since 1965 and is a 'sister' tax to IHT with, where not avoidable, one but both not generally applying. It should also be stressed that the following relates to CGT exposure for UK domiciled individuals primarily with assets in the UK as additional mitigation vehicles are available for those (domiciled or not) with external non-UK investments. At the time of writing CGT for higher rate tax payers is 28%.

General Exemptions (2014)

  • Individuals and personal representatives have an annual exemption of £10,900.00;
  • Trusts have an annual exemption of £5,450.00;
  • Chattels are exempt up to £6,000.00;
  • Entrepreneurs' Relief from lifetime capital gains is set at £10,000,000.00 with such gains subject only to a 10% CGT rate

Specific CGT Tax Exemptions/Mitigation Opportunities

  • Family Home Relief - Under sections 222-226, of the Taxation of Chargeable Gains Act, 1992 (TCGA), the sale of family home will be exempted from CGT but this of course is a relief that only applies to one elected home and not second or investment homes. Interestingly, this relief may not be lost for periods where owners are abroad working or in accommodation supplied by employers and indeed where a family home is rented out there is also the possibility of 'lettings' relief amounting in theory up to £80,000.00 for a couple;
  • Spouse to Spouse Transfers – Generally transfers from one spouse to another is exempted from CGT, which can provide significant tax mitigation opportunities where one spouse has a potential capital gains exposure;
  • Chattels Relief – As stated no CGT is payable on chattels that have been sold at a higher price than purchased;
  • Business Rollover Relief – To encourage business to reinvest and/or modernize there is generally no CGT if funds are re-invested back into the business;
  • Enterprise investment scheme (EIS) and Venture Capital Trusts (VCT's) investments can be made either avoiding CGT exposure or considerable reducing the tax payable;
  • Foreign Residence – A previously ordinarily resident UK individual not intending to return to the UK can avoid CGT exposure upon properly becoming resident abroad. However, since March 1998, if a UK ordinarily tax resident individual leaves the UK for a temporary period of non-residence, and for 4 out of the previous 7 years immediately prior to the year of departure was UK resident, and there are fewer than five years of assessment falling between the year of departure and the year of return then any capital gain is still liable to UK CGT. Thus, in simple terms for an individual intending to return to the UK, it is necessary to be abroad for at least 5 complete years of assessment to benefit from the exemption.

Notes:

The SCF Group does not provide tax planning advice save where there is a specific and agreed remit and issued 'letter of engagement'. All clients are therefore advised to ensure that their particular tax circumstances have been confirmed before proceeding with any corporate structure