You are about to start a holiday lettings company with a cottage to be gifted from your father. Should the gift be made directly to you or into your company, and what taxes do you need to consider?
Introduction
You own several investment properties. Your son has decided to start his own holiday lettings business and you have agreed to gift him a property from his own portfolio. In an effort to reduce the number of property transfers, you were planning on making the gift directly into your son’s new company.
The cottage has been used for residential letting by you and was bought for £300,000. The current value of the property is £400,000. What taxes will be triggered on the gift and would there be any advantages to gifting the property to your son, for him to gift to his company?
Capital gains tax
The first tax to consider is capital gains tax (CGT). The gift by you will be a disposal for CGT purposes with the sale proceeds deemed to be market value. This will create a dry tax charge for you and unfortunately, as the cottage has only been used for residential letting, no business asset disposal relief or gift holdover relief will be available to soften the blow.
Pro advice. The deemed sale proceeds will be the market value of £400,000, generating a gain of £100,000. CGT payable before the AE is therefore £28,000 (or £24,556 if the AE is available).
Planning
Whilst there are no CGT reliefs available for the gift, you may be able to mitigate the tax payable by undertaking some routine tax planning. An easy win would be to transfer the cottage into joint names with a spouse or civil partner in order to utilise their tax allowances.
Pro advice. Where a spouse is a basic rate taxpayer, their share of the gain up to the basic rate band will be taxable at 18% rather than 28%. In addition, the use of the spouse’s annual exemption will generate additional tax-free gains of £12,300.
Taking things a step further, the gift could be made in two parts and split across tax years, for example making the gift on 5 and 6 April in order to use another AE. This would mean almost half of the gain would be covered by the exemptions, assuming they are all available in full.
Pro advice. Where multiple linked disposals are made to connected persons within a six-year period, the market value of the property is taxed in full across all disposals, meaning no minority discounts can be applied.
Inheritance tax
Whenever there is a gift of an asset there will also be inheritance tax (IHT) implications. A gift made during lifetime will either be a potentially exempt transfer (PET) or an immediately chargeable transfer, with the former being exempt from IHT if the gift is survived by seven years, and the latter being immediately taxable (subject to the availability of the nil rate band).
To be a PET, a gift must be:
- made by an individual
- a chargeable transfer, in the absence of the PET legislation, i.e. not exempt; and
- made to another individual (or to a disabled persons trust or bereaved minors trust).
A gift of the cottage to the company would not be a PET and would therefore be an immediately chargeable transfer with IHT payable at the lifetime rate.
Example. The value of the cottage of £400,000 would be immediately subject to IHT, but if you have your tax-free nil rate band of £325,000 available in full, the taxable amount would reduce to £75,000. At 20% the IHT payable would be £15,000.
There is a clear benefit to making the gift to the son first so that it qualifies as a PET with no IHT payable immediately. Of course, as we saw with the CGT position, a transfer into joint names with the father’s spouse or civil partner would have the benefit of an additional nil rate band and could therefore eliminate the lifetime charge.
Stamp duty
In addition to the taxes due on the disposal of the cottage, there is also tax due on the purchase in the form of stamp duty land tax (SDLT), or the devolved equivalent.
You may be forgiven for thinking that as the company is not paying anything for the cottage, there should be no SDLT charge. Unfortunately, there is a market value rule that‘s applied whenever a company acquires a property from a connected person, with SDLT being due on the market value of the property. A gift from the father direct to the company would therefore trigger the charge.
Pro advice. The SDLT connected persons test is taken from s.1122 Corporation Tax Act 2010 , with the father being connected to his son’s company by virtue of him being connected to his son (who controls the company).
On the face of it no SDLT would be due if the father gifted the cottage to his son (as the market value rule only catches purchases by companies).However, once the son transfers the cottage into the company, SDLT will be due at that point. To make matters worse, SDLT will be due at the higher rates as the company is purchasing a residential dwelling. The 3% surcharge will be added to all bandings, therefore on a market value of £400,000, the SDLT charge to the company will be £22,000.
Loan account
We’ve seen that the CGT and SDLT treatment will be the same whichever route of gift is taken, but gifting direct to the son would be advantageous from an IHT point of view. Are there any further advantages to gifting to the son?
As CGT will be due on the father’s disposal based on the market value of the property, the son will receive the cottage with a base cost equal to that market value. This gives you an opportunity to generate a tax-free director’s loan account on the onward transfer to the company.
Pro advice. On transfer to the company the son will have deemed market value sales proceeds of £400,000, but his base cost will also be £400,000 and therefore no gain will arise.
Pro advice. Future profits of the company up to £400,000 can therefore be extracted from the company with no tax consequences for you.
Further issues
Lastly, there may be some non-tax issues to consider when making the decision about the route of gift. If the father makes the gift to the company, its value will be reflected on the balance sheet of the company in the form of a positive asset (after a revaluation to fair value).
In contrast, if the gift is to the son the value of the gift will sit with the son and be reflected in his director’s loan account. The result being a company balance sheet of nil as the value of the cottage is matched to the value of the loan due to the son. This may mean the company will have a lower credit rating if it needs to raise finance later on.
The capital gains tax and stamp duty land tax position will be the same regardless of which route is taken. Gifting direct to the son will have inheritance tax benefits and will also allow for a tax-free director’s loan account to be created. Whichever route is taken, consider splitting the gift between spouses to utilise multiple allowances.
This article has been reproduced by kind permission of Indicator – FL Memo Ltd. For details of their tax-saving products please visit www.indicator-flm.co.uk or call 01233 653500.