A common problem when making gifts of chargeable assets (e.g. land and buildings, shares, etc.) is that the person making the gift (i.e. the donor) is generally treated as having received disposal proceeds equal to the market value of the asset for capital gains tax (CGT) purposes.
Consequently, in many cases the donor is faced with a ‘dry’ CGT charge (i.e. there are no actual disposal proceeds from which to pay the tax on the gifted asset). This problem can arise not only on making pure gifts, but also on disposals otherwise than at ‘arm’s length’ (e.g. sales at undervalue).
Fortunately, two useful and popular forms of CGT relief can be claimed in this type of situation, if certain conditions are satisfied.
The effect of these ‘holdover’ reliefs, if available and claimed, is broadly to defer (or holdover) all or part of the CGT liability which would otherwise arise on the disposal of a chargeable asset, normally until a later disposal by the recipient of the gift. In other words, the gain from the donor’s disposal is effectively passed on to the recipient, as well as the gift itself.
The first of these reliefs is for gifts of business assets (TCGA 1992, s 165), which as mentioned can apply to sales at undervalue as well. The second, and perhaps less well-known, relief applies to gifts on which inheritance tax (IHT) is chargeable (or would be chargeable, but for certain IHT exemptions) (TCGA 1992, s 260). This article looks at some potential pitfalls in relation to the second of these reliefs (all references are to the Taxation of Chargeable Gains Act (TCGA) 1992).
Gifts, trusts and IHT
Claims for relief under s 260 most commonly arise when transfers are made to and from trusts. Most lifetime gifts by individuals into trust are not ‘potentially exempt transfers’ (i.e. they do not become exempt after seven years), and therefore result in an immediate IHT charge.
For example, a parent may wish to make a lifetime gift of an investment property into a discretionary trust for his adult children. A claim for relief under s 260 can allow the chargeable gain on the property which would otherwise accrue to the transferor to be held over, with the trustees’ base cost of the property being reduced by the held over gain. Similarly, if the trustees of the discretionary trust decide to transfer the property to one of the beneficiaries a few years later, it may also be possible for the trustees to claim relief under s 260, and defer the gain until a later disposal of the property by the beneficiary.
A very helpful feature of gift relief under s 260 is that it does not depend upon IHT actually being paid. For example, the relief is potentially available even if it falls within the individual’s IHT allowance (or ‘nil rate band’), or is covered by ‘business property relief’ at the 100% rate for IHT purposes (see HMRC’s Capital Gains manual at CG67041).
Traps and pitfalls
However, as with most useful tax reliefs, there are numerous potential pitfalls. Relief under s 260 may be restricted, denied or even clawed back in certain circumstances. The following is a selection of possible traps and pitfalls.
- Unexpected interest?
Holdover relief under s 260 is not generally available in respect of a gift to a ‘settlor-interested’ settlement. This anti-avoidance rule prevents for relief purposes not only the settlor (or spouse or civil partner, in most cases) being capable of benefiting from the trust, but also a ‘dependent child’ (i.e. a child who is under the age of 18, and is not married or a civil partner). This can give rise to unexpected and unfortunate results.
For example, suppose that a trust has been set up for the settlor’s family members (but excluding the settlor and spouse). Under the terms of the trust, the settlor’s newly born daughter becomes a beneficiary. This causes the settlor to have an interest in the settlement (s 169F(3A)), and holdover relief on a later gift to the trustees being denied.
The general restriction for gifts into settlor-interested settlements is subject to limited exceptions, broadly where the settlement is for a disabled person, or is a heritage maintenance fund (ss 169B, 169D).
- Sharp claws
Holdover relief which has already been claimed on a disposal may be withdrawn (or ‘clawed back’) from the transferor in some cases. This can broadly apply to the relevant disposal if (for example) during a ‘clawback period’ (i.e. up to six years after the end of the tax year of disposal) the trust becomes settlor-interested, or an arrangement comes into existence whereby the trust will, or may, become settlor-interested (s 169C(2)).
This anti-avoidance rule is widely drafted. In certain circumstances, a clawback of relief in respect of the gain on an asset can be caused inadvertently. For example, an individual (A) made an earlier gift of an asset, and claimed holdover relief on that gift. He subsequently acquired an interest in the relevant settlement during the clawback period. Individual A may or may not be connected with individual B, who made a later gift of that asset into the settlement which is subject to the clawback of holdover relief (s 169C(3); see CG67067A).
However, there is an exception from this clawback rule if the transferor dies before the ‘material time’, i.e. broadly the time when one of the clawback conditions first becomes satisfied (s 169C(6)). The general clawback rule is also subject to the same limited exceptions mentioned earlier (see 1 above), in relation to trusts for disabled person and heritage maintenance funds (s 169D).
- Bad timing
The timing of a transfer out of a trust to a beneficiary may be critical to the availability of holdover relief under s 260 in respect of that transfer.
For example, suppose that the trustees of a discretionary trust transfer a chargeable asset to a beneficiary. The trustees assume that this will give rise to an immediate IHT charge, and that holdover relief will therefore be available.
However, there is no IHT charge on a transfer which occurs within three months of the day on which the trust commenced, or within three months following a ten year anniversary of the trust (IHTA 1984, s 65(3)). If there is no IHT charge, no holdover relief under s 260 will be available either.
In addition, distributions within two years of a discretionary will trust being created on death do not generally give rise to an IHT charge (IHTA 1984, s 144(2)). Holdover relief under s 260 cannot therefore be claimed in such cases (see CG67041).
- Important ‘consideration’
Not all asset disposals are gifts. Some disposals are ‘partial’ gifts (e.g. sales at undervalue). Holdover relief is subject to restriction if the transferor receives consideration for the disposal. An immediate CGT liability may arise if the consideration received exceeds the allowable deductions in calculating the gain (s 260(5)).
Example – Sale at undervalue
Rodney purchased an investment property in December 1995 for £70,000. In March 2014, he sold it to the trustees of his family discretionary trust for £100,000. The market value of the property at that time was £220,000. Rodney makes a claim for holdover relief under s 260 (nb the trust is not settlor-interested).
The gain on disposal of the property is £150,000 (i.e. £220,000 – £70,000). The holdover relief claim is restricted by £30,000 (i.e. £100,000 – £70,000). The gain held over therefore amounts to £120,000 (i.e. £150,000 – £30,000).
Rodney is therefore liable to CGT (assuming that his annual CGT exemption has been used elsewhere) on £30,000 (i.e. £150,000 – £120,000).
- Which relief?
A holdover relief claim under s 260 can have unfortunate implications where the asset involved is a house. Principal private residence relief for CGT purposes (under ss 222, 223) on the disposal of an only or main residence can generally be restricted or denied on the disposal of the residence (from 10 December 2003) by an individual or settlement trustees, if the property’s base cost has been reduced following one or more s 260 holdover claims on its earlier disposal (s 226A).
The effect is broadly that a s 260 claim by trustees on the transfer of a property to a beneficiary prevents private residence relief being claimed by the beneficiary on a future disposal, or vice versa. Any future gain from the individual’s or trustees’ period of ownership is also denied private residence relief, including the held over gain element. This is subject to a measure of transitional relief in some cases, for certain disposals from 10 December 2003, when this anti-avoidance rule was introduced (FA 2004, Sch 22, para 8).
The above list is not exhaustive; there are various other circumstances in which holdover relief under s 260 can be adversely affected. What might appear like a straightforward CGT relief on the face of it is riddled with possible complications and pitfalls. Care is therefore needed; read the legislation carefully (and perhaps HMRC guidance as well); and if in any doubt, seek expert help.
The above article was first published by Tax Insider (www.taxinsider.co.uk).