Disposals of chargeable assets can trigger capital gains, resulting in a sometimes unexpected tax liability. This can be a particular burden if the disposal is a gift (or possibly a sale at undervalue), as there may be no or little proceeds to contribute towards the resulting tax liability.
A market value rule generally applies to disposals not at ‘arm’s length’. In other words, the market value of the asset is used to calculate a capital gain on its disposal, instead of the proceeds (if any) actually received. As indicated above, this can leave the person making the disposal with insufficient funds to pay the tax. Market value is substituted in any event for disposals between ‘connected persons’ (e.g. gifts from parent to child, or between siblings).
Passing down a business (e.g. from father to son) is one situation where this market value rule can be problematic. Even if capital gains tax (CGT) entrepreneurs’ relief is available to reduce the CGT rate from 28% to 10%, father (in this example) might feel aggrieved about having to pay any CGT at all, when all he is doing is passing down a long-standing family business to the next generation.
What a relief!
It was perhaps with such circumstances in mind that relief from capital gains is made available for gifts of business assets (note that the legislation refers to ‘gifts’, but relief can be available for sales at undervalue as well).
Like many other forms of tax relief, there are various conditions and potential pitfalls. The following is a selection of (possibly less well-known) issues and traps. However, there are various other ‘nasties’ not covered here. For example, this article generally focuses on gifts from one individual to another, but note that there are anti-avoidance rules which can apply to gifts to the trustees of settlements in certain circumstances (TCGA 1992, ss 169B-169G), and great care should therefore be taken when considering such gifts.
Another form of capital gains tax holdover relief (in TCGA 1992, s 260) is available in respect of disposals which give rise to an immediate inheritance tax charge (e.g. the gift of an investment property to the trustees of a discretionary trust), subject to certain conditions and anti-avoidance provisions. However, that relief is not considered in this article.
- Which assets?
Gift relief broadly applies to disposals of business assets, i.e. assets used in a trade, profession or vocation carried on by the transferor (as a sole trader or partner), his personal company or the trading subsidiary of a holding company which is his personal company. It also applies to disposals of shares or securities of a trading company (or the holding company of a trading group) where either the shares or securities are not listed on a recognised stock exchange, or the trading (or holding) company is the transferor’s personal company (a ‘personal company’ is broadly a company in which the individual can exercise at least 5% of the voting rights).
The relief also applies to disposals of assets which are ‘agricultural property’ for inheritance tax purposes where certain conditions are satisfied (TCGA 1992, Sch 7, para 1), and to certain disposals by settlement trustees (Sch 7, para 2).
However, gift relief is not available in some circumstances and for certain business assets (TCGA 1992, s 169(3)). For example, the relief is not available on a disposal of shares to a company.
- Investment trap
Gift relief is subject to restriction in certain circumstances involving the disposal of shares (TCGA 1992, Sch 7, para 7). Relief can be restricted broadly where the company’s ‘chargeable assets’ (or those of a trading group, on a disposal of the holding company’s shares) include non-business assets, if at any time within 12 months before the disposal the transferor controlled at least 25% of the company’s voting rights, or (where the transferor is an individual) the company is his ‘personal company’ (see 1. above).
Where this restriction applies, the held over gain is reduced by the fraction A/B, where A is the market value of company’s (or group’s) chargeable business assets, and B is the market value of all the company’s (or group’s) chargeable assets. A ‘chargeable asset’ is one which would give rise to a chargeable gain on its disposal.
Thus (for example) an individual who gifts shares in his personal trading company which owns a business premises and investment properties to a family member will need to apply the above fraction in calculating any reduction in the holdover relief available, based on the market value of those assets.
- Partial business use
Gift relief could also be restricted if an asset is not used for the purposes of the trade, profession or vocation throughout the transferor’s period of ownership (TCGA 1992, Sch 7, para 5). Holdover relief in such cases is reduced by the fraction A/B, where A is the number of days of non-business use, and B is the total number of days in the period.
Furthermore, in the case of a building or structure, if over the transferor’s period of ownership (or any substantial proportion of it) part of it is used for business purposes and part is not (e.g. a shop with a flat above it), a ‘just and reasonable’ fractional reduction is required; thus only a proportionate part of the gain on the building or structure is eligible for holdover relief (Sch 7, para 6).
However, the above restrictions do not apply broadly if the asset is eligible for inheritance tax agricultural property relief.
- So long, farewell
There is a potential holdover relief trap broadly where the recipient of the asset transferred subsequently emigrates. If relief has been given and the recipient ceases to be resident in the UK in the six years after the tax year of the relevant disposal and while still holding the asset in question, the held over gain generally becomes chargeable immediately before that time (s 168).
However, there is a relaxation in this clawback rule if an individual is sent to work overseas (i.e. where all the work duties are performed outside the UK, and the individual becomes resident in the UK again within three years, and while still holding the relevant asset).
To make matters worse, if the recipient does not pay the tax resulting from this clawback of relief within 12 months from the due date, HMRC can recover the tax from the transferor instead, if the tax is assessed no more than six years after the end of the tax year in which the relevant disposal took place.
- Mind your own business!
Limited liability partnership (LLP) members need to be aware of a specific provision which applies where the LLP ceases to carry on a trade or business.
An LLP carrying on a trade or business is normally treated as transparent for tax purposes, in a similar way to non-LLP partnerships. For capital gains purposes, this means that assets held by the LLP are treated as held by its members as partners, and that any dealings by the LLP are treated as dealings by its members instead (TCGA 1992, s 59A(1)).
However, this transparency is generally switched off when the LLP ceases to carry on the trade or business (e.g. at the end of a winding up process in most cases, or by going into liquidation). A member who owns an asset (or an interest in it) which he acquired for consideration treated as having been reduced by gift relief is treated as if a chargeable gain equal to the amount of the reduction accrued to him immediately before the LLP ceased to be treated as transparent (TCGA 1992, s 169A).
This treatment is intended to prevent postponed gains falling out of charge (see HMRC’s guidance at CG27080).
- Don’t forget to claim!
Holdover relief for gifts of business assets must be claimed. The claim must be made jointly by the transferor and transferee, unless the transferee is the trustee(s) of a settlement, in which case the claim is made by the transferor alone.
The normal time limit for holdover relief claims is four years following the end of the tax year of disposal (TMA 1970, s 43(1)). Late claims are possible where HMRC assessments are made due to careless or deliberate behaviour (under TMA 1970, s 36(1)); the time limit for making claims depends on the type of taxpayer behaviour (see CG66916). Late claims are also possible for HMRC assessments not made due to careless or deliberate behaviour (within TMA 1970, s 43A); the time limit for making claims in such cases is one year from the end of the tax year in which the assessment is made (see CG13751, CG66917).
It is important to note that the above list of potential issues is not exhaustive; there are various other circumstances in which holdover relief claims under s 165 can be denied or adversely affected.
The order of, and interaction with, other capital gains reliefs should also be noted; for example, relief under s 165 is not available if holdover relief under s 260 (‘Gifts on which inheritance tax is chargeable’) is available (TCGA 1992, s 165(3)(d)). It is also important to bear in mind that gifts or sales of business assets at undervalue can have implications for other taxes as well, such as income tax (e.g. as employment income of the recipient in certain circumstances) and inheritance tax.
HMRC requires that holdover relief claims must be made using the form on its Helpsheet HS295, or on a copy of the form (CG66914). Helpsheet HS295 can be downloaded from the GOV.UK website.
The above article was first published by Tax Insider (December 2014) (www.taxinsider.co.uk).