The tax implications of passing assets to the next generation

21 Apr 2022

Mother and daughter

For many, inheritance tax (IHT) is a growing concern and passing assets tax efficiently to the next generation can be a primary objective. This article considers the tax implications of gifting assets (excluding property) to the next generation to help mitigate exposure to IHT.

Gifting cash

Cash can be gifted tax-efficiently with no immediate tax charge because it is not a ‘chargeable asset’ for capital gains tax (CGT) purposes and, from an IHT perspective, it will be a ‘Potentially Exempt Transfer’ (PET). Accordingly, as long as the donor survives seven years from the date of the gift, it will not be subject to IHT on their death. If the donor survives at least three years, taper relief may apply to reduce any IHT charge arising.

Gifting chattels

Chattels are defined as tangible or moveable property. There are two types of chattels: cheap chattels and wasting chattels. A cheap chattel is any chattel with a predictable useful life of more than 50 years (such as paintings and antiques), whereas a wasting chattel is one with a predictable useful life not exceeding 50 years (such as racehorses and wine).

The main problem with gifting assets is that a CGT charge is likely to arise where the asset has increased in value, as the gift will be treated as a deemed disposal at market value for CGT purposes.

There are specific rules regarding the calculation of the CGT charge for cheap chattels, which can be grouped into three categories:

  • If the market value and acquisition cost are both below £6,000, the asset is exempt from CGT.
  • If the market value and acquisition cost both exceed £6,000, normal CGT rules apply.
  • Where only one of either market value or original acquisition cost exceed £6,000, the gain or loss is restricted using a form of taper relief.

However, where two or more chattels are gifted to the same person and those assets form part of a set, the above rules are overridden, and normal CGT rules apply. This is to stop the taxpayer from artificially benefitting from a lower CGT charge, as the set is likely to be more valuable than the sum of the individual items.

Antiques are a common example and, as there is no time limit, it can be difficult to track items that are gifted several years apart and even to identify what assets form part of a set.

For assets that have fallen in value, the gift will give rise to a capital loss. Usually, losses can be offset against any capital gains arising in the current tax year or carried forward to future tax years. However, where losses arise on assets gifted to a connected person (such as a relative), the loss will be restricted and can only be offset against future gains arising on disposals to the same person. In that instance, it may be better to sell the asset and gift the cash so as not to restrict the loss relief.

Wasting chattels are exempt for CGT purposes and can generally be gifted with no tax charge arising. There are a few exceptions to this rule, including assets where capital allowances have been claimed or where the asset is used in the trade of another person.

In addition to wasting chattels, there are other assets that are exempt from CGT, which could be gifted without incurring an immediate tax charge. These include cars, shares and securities held in an ISA, venture capital trust shares, shares in unquoted trading companies which qualified for income tax relief under the Enterprise Investment Scheme (EIS) or Seed Enterprise Investment Scheme (SEIS), qualifying investments in social enterprises, gilts issued by the UK government and certain loan stock.

From an IHT perspective, a gift of any of these types of assets would be a PET and would not give rise to an IHT charge so long as the donor survives seven years.

Gifts out of surplus income

This is a very valuable IHT relief, as it exempts immediately from IHT any gifts made from surplus income without the requirement to wait the usual seven-year period. The rationale being that IHT is a tax on capital which should not extend to gifts of income. There is no limit on the amount that can be given away, other than it must not exceed the donor’s surplus income, making it a very tax efficient way to restrict the growth of the donor’s estate.

For the relief to apply, the donor must be left with sufficient income to maintain their usual standard of living after the gifts are made, and it must form part of their normal expenditure. Normal in this context, means habitual or recurring and so it is important that the donor establishes a regular pattern of gifts, or at least an intention to make regular gifts. This could include setting up a standing order, paying grandchildren’s school fees or paying regular premiums on a life policy. One-off gifts or gifts for a special purpose will not qualify. HM Revenue & Customs (HMRC) is, increasingly, investigating these claims, and so it is important that good record keeping is maintained by the donor to demonstrate that the expenditure is normal.

Anti-avoidance

Care is needed when making gifts to minor children or if the donor is going to retain some form of benefit from the asset gifted, as this could make the gift ineffective for IHT purposes or give rise to additional tax charges.

Income arising from assets gifted to minor children can be assessed to income tax on the parent where the income exceeds £100 in a tax year. This is to avoid shifting income from the parent to the child to utilise their tax-free allowances.

In addition, for a gift to be effective from an IHT perspective, the donor must not retain any benefit from the asset, otherwise the asset will be taxed to IHT on the donor’s death, regardless of legal ownership. These anti-avoidance provisions were introduced to prevent a taxpayer from reducing the value of their estate for IHT purposes whilst continuing to benefit from the property given away. This could include situations such as a boat or caravan gifted to children where the donor regularly uses it for holidays or where a picture remains displayed in the donor’s home.

The anti-avoidance rules extend even further to prevent the donor from benefitting from assets which they once owned or which they assisted others to acquire. In this instance, an annual income tax charge can arise under the ’pre-owned asset tax’ rules. The legislation is complex, and we recommend seeking professional advice if any benefit is to be retained either directly or indirectly by the donor.

Gifting chattels and cash will help to reduce a taxpayer’s estate for IHT purposes, but careful consideration of the tax consequences is required to ensure the gift is both effective for IHT purposes and does not give rise to any unforeseen tax charges. It is important the donor does not retain any benefit from the assets gifted, nor assists others to purchase assets which they will benefit from.

For those taxpayers with significant incomes, gifts out of income can be a very valuable relief due to the immediate exemption from IHT.

Although gifting assets will reduce the value of the donor’s estate for IHT purposes, it is important the donor considers their future capital and income requirements and retains sufficient assets to enable them to live comfortably for the remainder of their lives. Any remaining IHT exposure could be sheltered by an appropriate insurance policy.

As always, we recommend that specialist tax and legal advice is sought regarding individual circumstances before taking any action.

If you would like to discuss any of the matters raised here, please contact your usual Saffery Champness contact, or speak to Suzanne Wasson.

You may also be interested in reading our article on the tax implications of gifting property to children.

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