Introduction
- One of the effects of Covid-19 is that for some the value of their investments has gone down. Compared with the devastation Covid-19 has wrought for many that concern may not seem significant. One might see it as a “nice problem to have”. It can nevertheless be a real concern.
- There is the whiff of cliché about the notion of turning threats into opportunities But the following outlines two particular points to do with lifetime IHT tax planning which may be viewed as tax planning opportunities arising from the threat of falling investment markets induced by Covid-19.
The basic aim of lifetime IHT planning
- The basic aim of lifetime Inheritance Tax (“IHT”) planning is to reduce the value of your estate on death and so minimise the IHT charge on death. Such planning generally involves outright gifts of assets to the younger generation.
- If you make an outright gift of assets to other individuals then whatever the value of that gift there will be no IHT when the gift is made and if you survive for at least seven years from when the gift is made there’ll be no IHT in relation to the gift in respect of your death.
The “freezing effect” on gifts for IHT purposes
- As just mentioned, in order for such gifts to be completely out of the net for IHT purposes you need to survive seven years after the gift is made. Nevertheless, if you were to die within seven years its value for IHT purposes would be the value as the date of the gift – and not the value at your death.
- So, for example, if you gift shares to your son worth £100,000 at the date of the gift and you die five years later when they are worth £150,000 it is the £100,000 – not the £150,000 – that is taken into account: all the growth in value of the shares is in the estate of your son. The value as far as the donor is concerned is frozen as at the date of the gift.
- Whereas, if you had held onto the shares until your death the full £150,000 would have been part of your estate and potentially subject to IHT at 40%.
The “make-believe” gain for capital gains tax (“CGT”) purposes
- Again, as mentioned above, if you make outright gifts (qualifying as “potentially exempt transfers” for IHT) then no matter how big the gift may be there will be no IHT at the time the gift is made. But the corollary is that there may be capital gains tax to pay.
- This may seem rather unexpected and unfair: after all, if you make a gift how can you make any “gain” out of it? That is a fair question. But the fact is that if you make a gift then for CGT purposes you will be treated as having “disposed” of the asset at its “open market value”. ( If the gift is simply a cash gift (in £sterling) then this aspect does not arise because cash is not a “chargeable asset” for CGT purposes.)
- So, there may be CGT to pay on a lifetime gift even although, in fact, there is no actual “gain”. There is – for tax purposes – a “make-believe” gain. This can discourage people from making gifts of assets that have increased in value over the years because it would involve paying CGT.
Coronavirus and rolling together the “freezing effect” for IHT and the “make-believe” effect for CGT
- Suppose: (1) you had a batch of investments worth £200,000 two years ago that are now worth £100,000; (2) you gift them to your daughter now; and (3) in five years time you die when the investments are again worth £200,000.
- In that case there will have been no CGT when the gift was made and no IHT when the gift was made.
- Given that you have died within seven years of the gift its value at the time it was made – i.e. £100,000 – falls to be brought back into account for IHT. The growth in value of £100,000 is all in your daughter’s estate: not yours.
- In this way, assets in your daughter’s hands now worth £200,000 have been gifted to her free of CGT and at a value of £100,000 – not £200,000 – as far as IHT is concerned.
- At the risk of over-stating the case you have turned a threat into an opportunity.
Note: This material is for information purposes only and does not constitute any form of advice or recommendation by us. You should not rely upon it in making any decisions or taking or refraining from taking any action. If you would like us to advise you on any of the matters covered in this material, please contact Heather Warnock: Heather@mitchells-roberton.co.uk