Tax Implications of Making Gifts

With the proposed measures for restricting agricultural property relief (APR) and business property relief (BPR), announced in the October 2024 Budget, due to take effect in April 2026, now more than ever, individuals are considering making gifts of assets during lifetime. This can be an effective strategy for estate planning and reducing future tax liabilities. However, individuals should be aware of the tax implications, particularly those related to Inheritance Tax (IHT) and Capital Gains Tax (CGT).

Inheritance Tax (IHT) is levied at 40% on estates exceeding APR, BPR and the nil-rate band (£325,000). However, making gifts can help mitigate this tax burden if done strategically. Here are the key considerations:

1. Potentially Exempt Transfers (PETs):

• Most gifts to individuals are considered PETs.
• If the donor survives for seven years after making the gift, and does not reserve a benefit in it, it is exempt from IHT.
• If the donor dies within this period, the gift may be subject to IHT based on a taper relief system, reducing the tax rate over time (from year 3 to year 7).
• Gifts of APR and BPR property from 30 October 2024 may be caught by the new measures if death occurs within seven years, but after April 2026.
• Consider life insurance to cover IHT should death occur within seven-years.

2. Chargeable Lifetime Transfers (CLTs):

• Gifts to trusts (excluding bare trusts), and sometimes to companies, are CLTs and may incur an immediate 20% IHT charge if they exceed APR and BPR reliefs and the nil-rate band.

3. Annual Exemptions:

• Each individual has an annual exemption of £3,000, which can be gifted tax-free.
• Unused exemptions can be carried forward for one year.
• Small gifts of up to £250 per person per year are exempt.
• Each tax year, you can give a tax-free gift to someone who is getting married or starting a civil partnership. You can give up to:

1. £5,000 to a child
2. £2,500 to a grandchild or great-grandchild
3. £1,000 to any other person

If you’re giving gifts to the same person, you can combine a wedding gift allowance with any other allowance, except for the small gift allowance.

4. Exempt recipients:

• Gifts to spouses or civil partners are entirely IHT-free.
• Gifts to charities and qualifying political parties are also exempt.

5. Exempt regular gifts out of income

You can make regular payments to another person, for example to help with their living costs, or tuition fees. There is no limit to how much you can give tax free, as long as:

• you can afford the payments after meeting your usual living costs and income tax liabilities;
• you pay from your regular monthly income. These are known as ‘normal expenditure out of income’.

If you’re giving gifts to the same person, you can combine ‘normal expenditure out of income’ with any other allowance, except for the small gift allowance.

As mentioned above, you need to ensure that a gift does not fall within the ‘gift with reservation of benefit (GROB) provisions which would make the gift ineffective for IHT purposes.

A GROB arises when an individual makes a gift of property to another person but retains some or all the benefit of owning the property – legislation defines a GROB with reference to the ‘enjoyment of the property’. If both the ownership and benefit are not transferred, then regardless of legal ownership, the property will be taxed as part of the estate of the donor.

The purpose of the GROB rules is to therefore prevent a person from trying to reduce the value of their estate whilst at the same time benefitting from what they have given away.

To avoid being classified as a GROB, the donor must therefore relinquish all benefits associated with the property. One option, for instance, would be to pay a market value rent to continue to use the property.

CGT should also be considered as it can arise at the time of gifting assets, when transferring assets with capital appreciation.

1. CGT on Gifts to Individuals:

• Gifting assets such as shares, property, or other chargeable assets can trigger CGT.
• The gain is calculated on the difference between the asset’s original acquisition cost and its market value at the time of the gift.
• The donor is responsible for paying CGT if applicable.
• The annual CGT exemption (£ 3,000 for 2024/25) can be applied to reduce the taxable gain.

2. Holdover Relief for Business and Agricultural Assets:

• If gifting qualifying business assets or agricultural property, holdover relief may be available to defer the CGT liability. However, there are restrictions depending on the period and part of qualifying use.
• If holdover relief is claimed, the recipient inherits the original base cost, and CGT is payable when they dispose of the asset.
• The CGT base cost of the asset will not be uplifted on death of the donor, even if the donor does not survive the seven-year period.

3. Gifts to Spouses and Civil Partners:

• Gifts between spouses, living together, or civil partners are free from CGT.
• The recipient inherits the donor’s acquisition cost, and CGT is only assessed when the recipient later disposes of the asset.

4. CGT on Gifts to Trusts:

• Gifts into most trusts are treated as disposals at market value for CGT purposes.
• Holdover relief may be available for certain types of trusts.

To optimise tax efficiency when making gifts, consider the following:

Utilise Annual Exemptions: Use the £3,000 annual gifting exemption to reduce taxable estate value over time.

Use PETs Strategically: Plan gifts well in advance, ensuring the donor survives the seven-year period to achieve full IHT exemption. Consider life insurance if there is a risk the seven-year period may not be met. Ensure there is no reservation of benefit in the asset given away.

Gift assets currently qualifying for holdover relief which may not in the future and may appreciate in value: For example, agricultural land which may be sold for development or leased for a solar park, or an agricultural building that may be converted to a dwelling. Consider life insurance for the seven-year period and ensure there is no gift with reservation of benefit.

Consider the use of Trusts: To retain control of an asset, as Trustee, and flexibility of discretionary decision making, delaying the need to decide who should benefit, consider using a trust to enable a gift earlier to start the seven-year IHT clock. Remembering that the donor cannot benefit from the Trust and the Trust has its own IHT regime, not discussed in this article.

Regular gifts out of income: Consider making regular gifts out of income which is exempt from IHT.

Seek Professional Advice: Given the complexities of IHT and CGT, consulting with a tax specialist is advisable.

Gifting assets can be a powerful tool in estate planning, but it requires careful planning to mitigate IHT and CGT liabilities. By understanding the tax implications and making use of available reliefs and exemptions, individuals can pass on wealth efficiently while minimising their overall tax burden. Properly structured gifts can provide significant financial benefits to recipients while ensuring compliance with UK tax.