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In the ninth of a series of extracts adapted from his eBook 'Hutton on Estate Planning' (3rd Edition), Matthew Hutton looks at estate planning involving family members.

The Family Unit - What is it?

Long gone are the days where the family unit might be generally understood as meaning husband, wife and 2.4 children. And in very many cases, the needs of what might be called ‘the extended family’ must be taken into account. However, for the purposes of this book I am concerned primarily with just two (or possibly three) generations and a fairly close-knit set of relationships. The older generation might be a married couple, a civil partnership, a couple living together or a single parent. The younger generation (if any) might be one or more children or step-children of any of the above, whether minors, or aged 18 or over. The basic fiscal framework requires one to consider:

(a) whether or not an IHT exemption, and indeed a CGT relief, applies on transfers of assets between members of the older generation;

(b) whether an anti-avoidance regime applies for Income Tax and CGT purposes in relation to income and gains accruing to individual minor children or trustees for them; and

(c) how gifts to or for the benefit of children are treated for IHT, i.e., whether made outright or in trust.

Transfers between Members of the Older Generation: Inheritance Tax

The IHT exemption has since 5 December 2005 applied equally to transfers between members of a registered civil partnership as to spouses. The interesting thing is that what matters is the legal relationship of marriage or registered civil partnership, not the fact that (as required by the CGT no gain – no loss rule) the couple are living together. Indeed, they may have separated many years before, but for whatever reason (religious or otherwise) have not broken the legal relationship: the IHT exemption remains. The only point to watch is the case where the transferor is UK domiciled but the transferee is not, for all IHT purposes, in which case the exemption is limited to £55,000 on a lifetime basis (IHTA 1984 s 18(2)).

Transfers between Spouses/Civil Partners: the Capital Gains Tax Position

By contrast, the rule that a transfer of assets between such individuals takes place on a ‘no gain no loss’ basis (TCGA 1992 s 58) depends upon the couple living together at some time in the year of gift, even if the transfer follows the date of separation. The test is the old Income Tax one for mortgage interest relief purposes, viz that if there is a separation it is likely to be permanent (now in ITA 2007 s 101).  Once the separation (or divorce) has happened, a transfer in a subsequent year will be treated for CGT purposes just as any other transfer between individuals, that is, a disposal with the market value being treated as received by the disponor. Interestingly, while the basic exemption applies, it matters not whether the disposal is by way of sale or gift: even if by way of sale the actual sale proceeds are disregarded and the ‘no gain no loss’ rule is applied, so putting the transferee spouse/civil partner in the shoes of the transferor in terms of inheriting his historic base cost.

Providing for Children: Income Tax

An anti-avoidance regime operates where income or gains arise to, or to trustees of a settlement for, minor children of the transferor/settlor (see 3.2.5). In broad terms, for Income Tax, subject to a de minimis limit of £100 per transferor per child per tax year, the income is treated as that of the parent (ITTOIA 2005 s 629). The only exception is the case where the transfer of assets occurred before 9 March 1999 and the income from those assets belongs absolutely to the child as it arises (i.e., in particular Trustee Act 1925 s 31 has been excluded, so that the trustees have no power to accumulate income, but must retain it for the child until such time as they can get a valid receipt, whether from the parent or guardian or from the child on attaining age 18). Income which is accumulated and then paid out in a subsequent year while the child is still under the age of 18 does not escape assessment on the parent settlor.

Providing for Children: Capital Gains Tax

A gift of an asset other than Sterling cash may trigger a gain on disposal. Where a positive tax charge arises, i.e., to the extent that neither the Annual Exemption of £10,100 (for 2010/11) or allowable losses are available, it may be possible to hold over the gain – with either a defined business asset or a gift into trust.
 
The anti-avoidance rule applying from 2006/07 to 2007/08 inclusive was similar to Income Tax where gains are made by trustees of a settlement under which a minor unmarried child of the settlor can benefit (and child includes a step-child). In that case the gains are treated as those of the settlor and thus can attract any Annual Exemption otherwise available. Any allowable losses or otherwise would attract tax at his marginal rate (TCGA 1992 s 77, repealed from 2008/09). As from 2008/09 the gains of a settlor-interested trust are assessed on the trustees. 

By contrast, if the assets are beneficially owned by the child, though because he is under age they are vested legally in someone else as nominee or bare trustee, the gains arising on disposal are treated as those of the child and thus are capable of attracting his Annual Exemption and/or (before 2008/09) lower CGT rates of 10% or 20% rather than those of the parent. As from 2008/09, in 2009/10 and for disposals in 2010/11 before 23 June 2010 there is a single rate of CGT of 18%, although there remains the advantage of the child’s Annual Exemption. For disposals after 22 June 2010 the rate is 28% to the extent that when added to taxable income the amount of taxable gains exceeds the basic rate Income Tax threshold of £37,400 - and otherwise 18%.  

The availability of the child’s Annual Exemption and tax rates for gains deriving from parental gifts to a minor may seem something of an oddity, though it is one of which many have historically taken, and continue to take, advantage. The disadvantage of course is that come age 18 the child can call for transfer of the assets into his own name absolutely.

Providing for Children: Inheritance Tax

Here the issue is whether the gift is made outright or in trust, no doubt for protection reasons. An outright gift will be a PET (i.e., free from IHT on the donor’s survival for seven years). By contrast, a gift into trust (except for a disabled beneficiary) will be an immediately chargeable transfer, free from IHT only insofar as it does not take the settlor’s seven year cumulative total of chargeable transfers over the Nil-Rate Band of £325,000 (in 2010/11 to 2014/15 inclusive). In either case the chargeable value may be reduced by 100% or 50% Business or Agricultural Property relief.

The above is an adapted extract from Hutton on Estate Planning 3rd Edition.

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