Inheritance Tax and Capital Gains Tax: The Benefits of Lifetime Planning

Inheritance Tax (IHT) is often referred to as a tax on death, but it can also be seen as a voluntary tax because careful planning can significantly reduce or eliminate it. In addition to IHT, Capital Gains Tax (CGT) can also be reduced through well-timed gifts and strategic asset transfers before death.

Using Lifetime Gifts to Minimise CGT and IHT

One effective strategy for reducing CGT and IHT liabilities involves making lifetime gifts, particularly between spouses or civil partners.

Normally, a gift of an asset (such as an investment property) between connected persons is deemed to be a disposal at market value, triggering a CGT charge. However, gifts between spouses or civil partners who are living together are treated as being made on a “no gain, no loss” basis, meaning there is no immediate CGT liability.

Upon the death of the recipient spouse, their estate is revalued to market value. Effectively eliminating any capital gains accumulated during the deceased spouse’s lifetime.

Example: Capital Gains Tax Planning Through Lifetime Gifting

Scenario:

• Andrew and Bethany are married and live in the UK.
• Bethany has been diagnosed with a terminal illness, with a life expectancy of less than a year.
• Andrew owns an investment property in London with a significant capital gain.

The tax planning steps taken:

1. Andrew gifts the property to Bethany.
   • Since the transfer is between spouses, there is no CGT liability.
2. Bethany inherits the property at Andrew’s original base cost.
3. Bethany passes away nine months later, leaving her entire estate (including the property) to Andrew.
   • Since assets transferred upon death are revalued to market value. The London property’s base cost is reset to its full market value.
4. Andrew now owns the property again, but with a higher base cost. If he sells it soon after, he will have little or no CGT to pay.

Tax outcome:

• No CGT is triggered on either transfer.
• No IHT is due, as transfers between UK-domiciled spouses are fully exempt from IHT.
• If Andrew sells the property shortly after inheriting it, CGT is minimised or eliminated because of the market value uplift on death.

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Is ‘Deathbed’ Tax Planning Abusive?

Whenever tax planning is undertaken, it is important to consider HMRC’s perspective. If an arrangement appears to be artificial or abusive, it may be challenged under the General Anti-Abuse Rule (GAAR).

GAAR is designed to counteract abusive tax schemes and applies where arrangements are deemed to be artificially structured to gain a tax advantage that was not intended by Parliament. If GAAR is applied, HMRC can adjust tax liabilities on a “just and reasonable” basis and impose a 60% penalty.

Does HMRC Consider This Type of Planning Abusive?

HMRC’s guidance on GAAR includes an example similar to the case of Andrew and Bethany, involving a gift of shares between spouses shortly before the death of the recipient spouse.

HMRC concluded that the GAAR would not apply in such cases, meaning that this kind of planning is not inherently abusive.

However:

• Just because GAAR does not apply, it does not mean HMRC fully approves of the arrangement.
• HMRC may still open an enquiry if it believes the transactions were orchestrated solely for tax purposes rather than for a genuine commercial or personal reason.

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Key Considerations for Effective IHT and CGT Planning

To reduce the risk of an HMRC challenge, it is important to ensure that any lifetime gifts or transfers are structured correctly.

1. Timing of Gifts

• Ideally, gifts should be made well in advance of death, as transfers made in obvious anticipation of imminent death may attract HMRC scrutiny.
• If a recipient spouse lives for at least a few months after the transfer, the planning is less likely to be challenged.

2. Ensuring a Legitimate Purpose for Transfers

• HMRC is less likely to challenge arrangements that have a commercial or personal rationale, rather than purely tax-driven motives.
• If, for example, Bethany was going to manage the property, that could provide a stronger justification for the transfer beyond just tax benefits.

3. Structuring Transfers to Avoid HMRC Scrutiny

• The gift and inheritance should be part of a broader estate plan. Rather than a last-minute transaction designed solely to reduce tax liabilities.
• If other assets are included in the will and estate planning process, it may help to demonstrate that the tax planning was part of a long-term strategy rather than an artificial scheme.

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Conclusion

IHT and CGT planning can significantly reduce tax liabilities, particularly between spouses or civil partners. The strategy of transferring assets to a spouse with a shorter life expectancy before death can be an effective way to:

• Eliminate CGT by resetting the base cost of assets upon death.
• Minimise IHT exposure, as transfers between spouses are fully exempt.

Final Takeaways:

1. Gifting assets between spouses can eliminate CGT liabilities if structured correctly.
2. No IHT is payable on transfers between spouses, making this strategy very tax-efficient.
3. Ensure that the arrangement has a clear personal or commercial rationale to reduce the risk of HMRC scrutiny.
4. Plan well in advance of death to strengthen the legitimacy of asset transfers.
5. While GAAR does not apply in these cases, HMRC may still investigate. So clear documentation and proper estate planning are essential.

For individuals with significant investment assets or business interests, engaging in early succession planning is crucial to optimising tax efficiency and ensuring assets are transferred in the most tax-effective manner.