If you require any further information on the items featured in this newsletter or indeed advice on any other Private Client matter, please contact one of our Private Client solicitors.
In this issue of our Private Client Newsletter:
- Capital Gains Tax Reliefs
- Can we give our holiday home to our children?
- How long does it take to administer an estate?
- Pre-Nuptial Agreements
Capital Gains Tax Reliefs
Entrepreneurs’ Relief and Principal Private Residence Relief. Capital Gains Tax (“CGT”) is a tax on any gain you make on a capital asset when it ceases to belong to you.
This can be when you sell an asset, give it away or exchange it. CGT is not to be confused with Inheritance Tax (“IHT”) which is a different tax, although it also involves the taxation of capital assets.
Everyone has an allowance (not the same as the £3,000 annual allowance in relation to gifts of capital) which is the amount of profit (or deemed profit) you can make each year without there being any tax payable. This is renewed every year.
For the tax year 2013/2014, this was £10,900, and for the tax year 2014/2015, the allowance is £11,000. Unused CGT allowances cannot be rolled forward into later years.
In addition to the annual allowance, there are a number of reliefs that can be used to reduce the amount of tax payable if an individual is eligible.
Two of the reliefs which our clients regularly find useful are Principal Private Residence Relief and Entrepreneurs’ Relief.
Principal Private Residence Relief:
As a general rule, the sale proceeds from an individual’s principal residence are not subject to CGT due to Principal Private Residence Relief (“PPR”). To qualify, the property has to have been used as the individual’s principal private residence for the whole period that they have owned it.
Some periods of temporary absence are allowed as long as there is a valid reason for the absence and it is for a reasonable period (e.g. they are away with work or due to illness). Otherwise, if the property has not been the owner’s principal private residence for any period then the relief is reduced proportionately.
Any land associated with the property is exempt from CGT up to 0.5 hectares. This can be extended to larger areas of land if it is deemed as required for the reasonable enjoyment of the residence. Anyone seeking to sell a property at a gain which has extensive land should seek advice on this particular issue.
In situations where two houses are owned and both are used as a private residence, an individual must elect which house they want to be deemed as their principal private residence for CGT purposes. If the taxpayer fails to elect within two years of the purchase of the second property, HMRC will decide the matter based on the facts. The right to elect which is your principal
residence is due to be revoked, so that in future it will simply be a matter of fact.
Where a person disposes of a property that has been their main residence, they are entitled to relief on the final period of ownership. This is in order to give individuals time to sell a property after moving into a new one. The relief used to be available for the final 36 months of the period of ownership.
However, due to the advantage that it gave people with second homes, the Government has seen fit to reduce the period eligible for relief to the last 18 months.
Entrepreneurs’ relief (“ER”) allows individuals to claim relief on the sale of a trading business, assets in a trading business or shares in a trading company. It is designed to assist expanding businesses.
There is a lifetime limit on the amount of gains for which the relief is available, which is currently £10,000,000.
In respect of the sale of a business (or part of a business) or business assets, a person is only eligible for relief if they have an interest in the business, i.e. they are a partner or sole trader.
When dealing with a sale of shares, the shareholder must be an officer or employee of the company and their holding must make up at least 5% of the total shareholding plus the shares must give them at least 5% of the voting rights. All of these conditions must have been met for a period of 12 months prior to the sale.
If the individual and the asset in question qualifies, then any CGT liability is payable at 10% (up to the lifetime limit) instead of the usual rate of 18% or 28% (for higher rate taxpayers).
These reliefs are useful tools and can result in substantial tax savings. The above is, of course, a snapshot of the potential relief available and each case has to be considered on its facts.
It is, therefore, prudent to seek legal and tax advice before disposing of an asset which is likely to result in a gain.
Can we give our holiday home to our children?
Many people’s fondest memories are of time spent with their children at a holiday home.
They want the holiday home to continue to be used by all the family in the future. Therefore the idea of giving the home to the children satisfies two desires – to enable family holidays to continue at a place which is loved, and to save Inheritance Tax. But there are pitfalls involved. In any gift of property you have to consider both Inheritance Tax (“IHT”) and Capital Gains Tax (“CGT”).
The gift of the holiday home (“the Property”) will be valid for IHT purposes if the parents no longer retain a benefit in it. What this means is that if the parents visit by themselves, they would have to pay rent to the children at a commercial rate.
For many families this of itself puts an end to the idea. An alternative is to work out how much the Property is used by the different members of the family and for the parents to retain a share equal to their usage.
Although this does mean the gift of the remaining share to the children is valid, the problem is use tends to vary with time.
For instance, while the parents and the children are all working adults, their use may be equal. But when the parents retire and the children have young children of their own, it may be the parents are there a lot more than the children and this would invalidate the gift.
Obviously the outgoings of the Property would have to be borne by the relevant people in the appropriate proportions.
If you do make a valid gift of the Property, or a share in it, after seven years the value of the gift will be outside your estate for IHT purposes. You might consider term life assurance to cover the IHT which would be payable if you did die within 7 years.
Capital Gains Tax
If the Property has been in the family for many years it may have accrued a capital gain. Your main residence is exempt from CGT, but this exemption does not apply to any other home. If you make a gift of property you are deemed to have disposed of it at its market value on the date of the gift.
If market value at that date exceeds the cost of acquiring the Property then the excess is a chargeable gain and if it is above your annual allowance (£11,000 per person this year) then CGT will be due even though you have not received any money.
The gain is added to your income and to the extent you remain within the basic rate band, CGT will be charged at 18% of the gain. Once you are above the basic rate band, CGT is charged at 28%.
What about a gift to a trust?
The above has assumed that the people receiving a share in the Property would be the children themselves. However, this could cause problems if they get divorced, or die, or get into financial difficulties. An alternative is to give the Property (or the appropriate share in it) to a discretionary trust of which the children and grandchildren are beneficiaries.
Then the Property will belong to the trust rather than the individual child and will not be at risk on divorce (provided the Property has genuinely been used by the whole family) or bankruptcy, nor will it suffer IHT if a beneficiary dies. In addition, any CGT may be deferred by use of a “holdover election”, which means the trust takes over the Property with its original acquisition cost.
However, a gift into a trust of an asset worth more than £325,000 will cause an immediate charge to IHT at 20% of the excess.
In addition, although there is no 40% charge on the death of a beneficiary, there is a charge to tax every ten years at a maximum rate of 6% on the assets then in the trust which exceed the IHT threshold at that time.
It is clear from the above that a proposed transfer of a holiday home requires careful planning. Plenty to think about next time you’re there!
How long does it take to administer an estate?
When somebody dies, the task falls to their Personal Representatives to administer their estate.
Personal Representatives (“PRs”) may be nominated by the deceased’s Will or, where there is no Will, be determined by a set order of priority. In both cases, it is the duty of the PRs to collect the assets of the deceased, pay off their liabilities and distribute what is left amongst the beneficiaries.
The process is made up of 3 key stages:
- Assessment of the assets and liabilities of the estate.
- Application for Grant of Probate/Letters of Administration (“the Grant”).
- Collection of assets and distribution.
1. Assessment of the Estate
The first task for PRs is to gather information about the deceased’s estate. This can involve writing to the bank, instructing agents to value the home and making enquiries with their creditors. The time this takes will depend on the speed of response from the various institutions, and the nature of the assets involved. Foreign assets, or complex investments, may take time before the value or the correct tax treatment can be ascertained.
Once the extent of the estate has been confirmed, the PRs must complete an Inheritance Tax Account. The valuations will reveal whether the estate will attract an Inheritance Tax charge, in which case a full Account must be completed and sent to HMRC, together with payment of any tax payable. In order to avoid any penalties, the Account must be filed within a year from the end of the month of death, whilst tax becomes payable six months from the end of the month of death.
The PRs will need to wait for HMRC to confirm receipt of the Account before an application for the Grant can be made at the Probate Registry. If the estate does not require a full Account, a smaller form can be completed and sent to the Probate Registry with the application for the Grant.
2. Application for the Grant
Where the deceased died leaving a Will, the application for the Grant is usually very straightforward. The Executors named by the Will must swear an Oath confirming the death of the deceased, the validity of the Will and the size of the estate.
This is sent to the Probate Registry with the original Will, the probate fee and tax documentation. Where the deceased did not prepare a Will, the application is a little more complicated as the PRs will need to demonstrate their legal right to administer the estate.
Provided the Probate Registry is happy with the application, the Grant is usually sent out within 2-3 weeks.
3. Collection and Distribution
The Grant gives the PRs legal authority to deal with the deceased’s assets. Once received, the PRs can begin to collect in, transfer and sell the assets in order to pay off the liabilities.
However, they should refrain from distributing the assets to beneficiaries until all liabilities have been paid and clearance has been received from HMRC confirming that no further tax is payable.
Claims can be issued against the estate for up to 6 years after the date of death. The PRs will be personally liable for such claims if they know of them, or should have known of them, but distributed the assets anyway.
As a result, PRs cannot be compelled to distribute assets to the beneficiaries unless unreasonable delay has occurred. Interest on unpaid legacies does not start to run until after the first anniversary of the death of the deceased, known as the “Executors’ year”.
This allows the PRs time to collect in the assets and obtain probate without pressure from the beneficiaries.
We are often consulted by parents who are worried about the consequences if they give substantial assets to their children and their children subsequently get divorced.
Our family lawyers are experts at advising on the steps you can take to protect your family financially.
Pre-Nuptial Agreements can be useful to help protect assets built up prior to marriage including inherited wealth.
A Pre-Nuptial Agreement can also be used to regulate the ownership of property going forward. You may want a Pre-Nuptial Agreement put in place to protect assets you intend to earmark for your children or other dependents.
Under English law, Pre-Nuptial Agreements are not automatically enforceable. However, if each party enters into the agreement freely and voluntarily, with independent legal advice, such an agreement will be regarded as a relevant factor to consider within subsequent divorce proceedings, when the court considers how the assets should be distributed fairly between the parties.
Recent Law Commission guidance recommends that Pre-Nuptial Agreements which meet certain criteria (‘Qualifying Nuptial Agreements’), should be legally enforceable. It is therefore the case that legally enforceable Pre-Nuptial Agreements may be on the horizon.
Pre-Nuptial Agreements can be used to provide clarity as to what each party intends from the outset. Such an agreement might reduce the cost of legal advice and potential court litigation, should the relationship subsequently break down.
The law affecting unmarried couples differs from the law protecting the rights of married couples or civil partners. Very few think about the legal issues surrounding their living arrangements, and often assume that they are protected by so called “common law marriage” rights, which do not legally exist.
If you or a family member are investing in a property with a partner, it is important to get legal advice at the earliest opportunity. You may be in a situation where you plan to provide more by way of a deposit on purchasing the property, and you wish to protect your extra investment.
You can do so by your family member entering into a Declaration of Trust at the time of purchase, which will mean that the property is owned in distinct percentage shares, rather than equally, as joint tenants.
You should also consider whether a Cohabitation Agreement is appropriate. These are being used more and more to provide clarity for unmarried couples wishing to regulate the terms of their relationship.
An agreement can provide written evidence of what each individual intended at the outset, as to their respective ownership of property, and what they each intend to happen in the future.
Cohabitation Agreements are especially useful for couples who are entering into a new relationship after the collapse of a previous relationship or marriage, or for those who own more assets than their new partner.