Tax Clinic Christmas 2009 - CGT on Incomplete Contracts, Transferring Assets to a Spouse, IHT and Domicile, Using International Companies to Avoid UK Tax, Entrepreneurs Relief when Winding Up a Company, Related Settlements

Malcolm Finney considers if Capital Gains Tax arises on contracts which do not complete, transferring assets to a spouse or civil partner, the effect on Inheritance Tax of domicile and international treaties for an international estate including UK assets, potential pitfalls of using an international company to avoid UK tax, Entrepreneurs' Relief when winding up a company, and issues arising from 'related' settlements.

Is Capital Gains Tax Due on an Incomplete Contract?

This apparently straight forward query gave rise to an interesting discussion between various contributors.

The fundamental issue which the query gave rise to, was a need to identify when a “disposal” occurred for Capital Gains Tax purposes.

In Capital Gains on Incomplete Contract PinkBird asked:

“My brother has paid his girlfriend £330,000 such that she can pay off her mortgage. They have drawn up a contract whereby if he pays her £350,000 (half the property value) he will have a half share in the property. However he cannot afford to complete this contract currently and I am concerned that his girlfriend may be liable for Capital Gains Tax on this sum as a result.

Can anyone let me know what the situation is re tax on the £330k???”

What emerges from the discussions is that the common understanding that a Capital Gains Tax liability arises on the “exchange” of contracts (not on “completion”) is only correct if “completion” actually takes place. A disposal will then have occurred. In the present query, completion does not appear to have happened due to a lack of cash on the part of the buyer and thus no disposal (despite the exchange of contracts) has arisen.

Contributor Maths refers to three relatively recent key cases which support the above statement.

TCGA 1992 s 28, which determines the timing of a Capital Gains Tax liability under a contract is, according to the courts, a “deeming” provision but is applicable only where completion thereafter takes place. Should completion not occur for whatever reason (and assuming the equitable remedy of specific performance is not imposed) then the beneficial interest which would normally pass on exchange of contracts is regarded as not having occurred (effectively, the contract becomes null and void).

So in PinkBird’s case the girlfriend does not have a Capital Gains Tax liability, as yet, as completion has not occurred. Should she agree to the lesser figure of £330,000 (or as and when the full £350,000 is paid) then on completion a disposal will have occurred and a Capital Gains Tax charge arises; the disposal then being deemed to have occurred at the date of exchange.

Transferring Asset to Spouse or Civil Partner

In Transfer of Shares to Wife, Rudy raises the issue of transfers between husband and wife, in this case a transfer of shares.

Although there is ambiguity in his query, as msp points out on such transfers no Capital Gains Tax charge arises as inter-spouse transfers are deemed to have occurred at “no gain/no loss” i.e., the wife (in this case) basically takes over the original base cost of the shares to the husband.

The transfer can be effected most easily by the husband simply executing a declaration of trust in the wife’s favour. Such a declaration transfers the beneficial interest in the shares immediately; (i.e., this is the disposal date for Capital Gains Tax purposes); should the husband/wife require the legal title also to be transferred then this can be done but from a purely tax perspective is not necessary.

The use of such declarations is an effective mechanism for precipitating taxable events where otherwise the matter would be delayed due to other legal formalities (e.g., in the present case and without the declaration, the taxable event would only arise once the husband had transferred the legal title which would only occur once the shares were registered anew in the company’s register of members).

Domicile

Hiya's query on Domicile is one of many related topics which regularly appear on the forum.

Unfortunately, it is rarely possible for contributors to give definitive advice as domicile determinations are typically questions of fact; this was the case here.

One particularly important fact to note is that made by contributor Taxbar with respect to the UK/India Inheritance Tax Convention.

Assuming hiya was to be held to be Indian domiciled then under the above Convention, her exposure to UK Inheritance Tax is restricted to certain UK situs assets (i.e., non-UK and non-Indian situs assets are only exposed to Indian inheritance taxes but not UK Inheritance Tax).

The UK is a party to only a small number of inheritance tax conventions and the provisions of each can vary quite significantly; thus, it should not be assumed that what applies under one convention will apply under all the others. This is particularly so given that a number of the conventions were concluded in the old estate duty days and are thus very different to those which conclude much later.

Pitfalls of Using International Companies to Avoid UK Tax

Thodge78's query concerns the possible use of an International Property Company by a UK resident, to avoid UK tax.

This is by no means easy to achieve.

A UK resident individual who simply sets up an offshore company (e.g., in the British Virgin Islands - BVI) which carries on the relevant trade faces two major obstacles. The first is that the BVI company, whilst incorporated in the BVI, is likely to be treated as UK resident due to its management and control being de facto exercised from within the UK, (normally by the individual who set up the company) thus falling subject to UK Corporation Tax on its worldwide income/gains. The second is that the UK tax legislation contains a raft of anti-avoidance provisions, the basic thrust of which are to attribute to the individual the income of the offshore entities (e.g., the BVI company) thus precipitating a UK Income Tax charge.

It was the second point to which contributor Taxbar refers in his response. He also makes the more “scary” point that a failure on the part of the individual to disclose the income on his/her Tax Return constitutes tax evasion (i.e., it is a criminal offence). The problem for the individual is that he or she may well be completely unaware of these complex anti-avoidance provisions and thus fail to make the requisite disclosure; however, ignorance of the law (as the saying goes) is no excuse.

Any individual contemplating utilisation of offshore entities, (be that companies/trusts), in particular in view of the anti-avoidance provisions, should take professional advice if, as Taxbar suggests, an allegation of tax evasion is to be avoided.

Entrepreneurs’ Relief when ‘Winding Up’ a Company

In recessionary times many businesses fail and/or owners decide to bail out.

However, all is not doom and gloom as a favourable Capital Gains Tax treatment may ease the pain – Entrepreneurs’ Relief.

Where such relief applies the rate of Capital Gains Tax is nearly halved from 18% to 10%.

Shotokan raised the following in his question Entrepreneurs' Relief/ESC C16:

“I can't seem to get a definitive answer on this one. Wonder if anyone can help.

Client runs a hotel through a ltd co but owns the actual property personally. No rent is paid. He sells the hotel and then applies for the company to be wound up under ESC16. Does the sale of the property qualify for ER under the "associated disposal" rules? The "sale" of shares under ESC16 takes place after the asset sale but it can't really be done the other way round”.

As contributor AvocadoK confirms:

“The legislation doesn't specify that the disposals have to take place in any particular order. The main thrust of the associated disposal rule is that the disposal of the hotel must be made as part of the withdrawal from participation of the business. Provided you wind up the company reasonably promptly after the disposal of the asset, and the other conditions are all met, ER should be due”.

Thus, carried out carefully, a withdrawal from the business can give rise to Entrepreneurs’ Relief. As AvocadoK indicates it is very important, if the “associated disposal” rules are to apply, that the asset disposal (i.e., the hotel in the above scenario) is effected as part of the withdrawal from the business and not effected as a totally separate transaction.

(See also Entrepreneurs' Relief for a non-Active Partner for another, related, issue helpfully resolved by AvocadoK).

The Problem With Related Settlements

As a general rule “related” settlements should be avoided for Inheritance Tax purposes.

Settlements are “related” if they are created on the same day by the same settlor. This may well arise if two settlements are created by a testator under his will (e.g., a Nil Rate Band trust plus a discretionary trust of the residue).

Similarly, of course, settlements may be related if created on the same day in lifetime.

The disadvantage of related settlements is that in ascertaining the ten-yearly and exit charges of a relevant property trust, account has to be taken of chargeable transfers made into related settlements thus exacerbating any Inheritance Tax charge. The concept is only relevant for relevant property trusts but post FA 2006 the range of such trusts has greatly increased (e.g., pre FA 2006 the creation of a discretionary trust and an interest in possession trust on the same day would not give rise to related settlements whereas post FA 2006 they would be ‘related’).

In his query Related Settlements,  Bill2 asks if two trusts would be related in a scenario where, on death, a new 'Nil Rate Band Trust' were created, and the residue of the estate were passed to a pre-existing discretionary trust, on the basis that assets would be transferred to two trusts on the same day.

As contributor Lee Young comments, the current query does not give rise to related settlements as they have not been created on the same day. It is perfectly possible for an individual to create a trust in lifetime and a separate trust by will, which will not be ‘related’ (i.e., not created on the same day) even if under the will some property is added to the pre-existing lifetime will.

Article Added Sunday, 03 January 2010

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