CHAPTER 24 GIFT RELIEF FURTHER ASPECTS AND EXCHANGES OF ASSETS

CHAPTER 24 GIFT RELIEF FURTHER ASPECTS AND EXCHANGES OF ASSETS In this chapter you will cover some further aspects of gift relief and the rules in relation to exchanges of assets including: residence status of the donee; instalment option for CGT on gifts; partial business use; gift relief on divorce; exchanges of assets. 24.1 Residence Status of the Donee A gift relief claim can only be made if the donee (the recipient) is resident in the UK. TCGA 1992, s.166(1) To be within the charge to UK capital gains tax, an individual must live in the UK. HMRC will not allow a capital gain to be deducted from the base cost of an asset owned by somebody who is outside the scope of UK CGT. Once a gift relief claim has been made, the deferred gain is clawed back if the donee emigrates within six tax years. If a donor gifts an asset to a donee and a gift relief claim is made, if the donee leaves the UK within any of the following six tax years, the deferred gain is charged on the donee at the date of his emigration. TCGA 1992, s.168 This rule can present HMRC with a problem, because the person who now has a CGT liability i.e. the donee no longer lives in the UK, and therefore collection of the capital gains tax could be difficult. Therefore if the donee fails to pay the capital gains tax within 12 months of the normal due date, HMRC have the right to pursue the donor for the donee's tax. Illustration 1 A donor gifts a business asset to a donee in March 2011. The donor makes a capital gain of 20,000, and a gift relief claim is made to defer this gain. In July 2015, the donee leaves the UK permanently. Discuss when the capital gains tax is due and how it will be collected by HMRC. Because the donee has emigrated within six tax years of receiving an asset on which a gift relief claim was made, the deferred gain i.e. 20,000 becomes chargeable on the donee in 2015/16 i.e. the year of emigration. As this is a gain in 2015/16, the CGT is payable no later than 31 January 2017. However, at this point the donee will be living in another country and may not feel inclined to pay his UK tax bill. HMRC will wait for 12 months i.e. until 31 January 2018. At this point, HMRC can write to the donor and ask him to pay the donee's tax. Note that this will not change the amount of tax due, which will have been calculated using the donee's rates and annual exemption etc. Reed Elsevier UK Ltd 2015 229 FA 2015

These rules do not apply if the donee leaves the UK on a full-time contract of employment and returns to the UK within three years. Neither do the rules apply if the donee had sold the asset prior to his emigration. 24.2 Payment by Instalments In certain circumstances an individual can make an election to pay his capital gains tax in instalments. Under s.280, if a vendor receives his consideration in instalments, and the instalment period exceeds 18 months, it may be possible to spread the CGT due over a period which cannot exceed 8 years. TCGA 1992, s.280 There is another instance when capital gains tax can be paid in instalments, this time under s.281 TCCA 1992. Section 281 applies if a donor gives away an asset and cannot claim gift relief to defer the capital gain. If the donor makes an election, the CGT due can be paid in ten equal annual instalments. Typically this will be the case when the donor gives away a non-business asset and cannot claim gift relief under s.165. TCGA 1992, s.281; TCGA 1992, s.281(2) The instalment option is only available in respect of gifts of certain assets. CGT due in respect of gifts of land and buildings can be paid in instalments. For example, if a donor gives away a building which is not used for the purpose of a trade, because no gift relief will be available, the CGT can be paid in instalments under s.281. The reason behind the legislation is that the donor does not have any cash to pay the capital gains tax, so HMRC will accept the tax in instalments. TCGA 1992, s.281(3) Tax on gifts of shares in unquoted companies can also be paid in instalments. Tax on gifts of quoted shares can only be paid in instalments if the donor controls the company i.e. the donor has more than 50% of the voting rights. Unquoted shares or shares in a personal company are usually qualifying assets for gift relief purposes, but only if the company is a trading company. Therefore when an individual gives away shares in an investment company he will usually be able to pay his tax in instalments. Although HMRC are happy to accept payment of tax in ten equal instalments, these instalments will be interest-bearing. This means that interest on the unpaid balance of tax will be added to each annual instalment. TCGA 1992, s.281(6) Illustration 2 In May 2015, Rita gives a building to her daughter Jennifer that had cost her 80,000. The building is a non-business asset. The building is worth 200,000 in May 2015, leaving Rita with a capital gain, of 120,000. As this is a non-business asset, gift relief is not available. Rita is a higher rate taxpayer who did not make any other disposals in 2015/16. Proceeds (MV) 200,000 Less: Cost (80,000) Gain 120,000 CGT: (120,000 11,100) @ 28% 30,492 Rita therefore has capital gains tax of 30,492 to pay no later than 31 January 2017. Reed Elsevier UK Ltd 2015 230 FA 2015

How could Rita defer this tax? Calculate the amount payable on 31 January 2018, assuming an interest rate of 3%. Are there any circumstance where the deferment would no longer be applicable? Rita can make an election under s.281 to pay her tax in instalments. This is because tax is due on a gift of a qualifying asset i.e. land or buildings and no gift relief is available. Assuming Rita makes a claim under s.281, she will pay her tax in ten annual instalments starting on 31 January 2017. The second instalment will be due on 31 January 2018. This will be another 10% of the tax being 3,049. However, because the instalments are interest-bearing, HMRC will add on one year's interest on the unpaid balance of tax at 31 January 2017 of 27,443. 31 January 2018 Tax 3,049 Interest on 27,443 @ 3% (assumed) 823 3,872 This will happen each year until the total tax has been discharged. Finally here, if Jennifer sells the asset, any tax unpaid by Rita, together with any accrued interest, becomes due and payable and the instalment option ends. Tax can also be paid in instalments if the donor has made a gift relief claim, but there is still a chargeable gain remaining after the relief has been given. This may apply if the donor is gifting shares in his personal trading company, but as the company holds non-business assets, gift relief is restricted under the CBA/CA rule. 24.3 Partial Business Use Gift relief is restricted if an asset is partly used for business and partly used for nonbusiness purposes. Section 165 only gives relief for gifts of business assets, therefore some apportionment will need to be made if an asset is partly used for nonbusiness purposes. For example, a trader uses 75% of a building for business purposes and 25% for nonbusiness purposes. The donor gives the building away, and has a capital gain on the disposal. 75% of this gain can be deferred under the gift relief rules, because 75% of the asset was used for business purposes. The remaining 25% of the gain is immediately chargeable and CGT will be payable. In this instance, it would be possible for the donor to pay this tax in instalments. TCGA 1992, Sch 7 para 6 A similar apportionment needs to be made if an asset was not used for the purposes of a trade for part of the donor's ownership period. The gain arising in the business period would qualify for gift relief, whereas the gain arising in the nonbusiness period would be immediately chargeable. When calculating the business and non-business proportions, any business or non-business use of an asset before 1 April 1982 can be ignored. TCGA 1992, Sch 7 para 5 It is important to note here that gift relief is only available where the asset in question is a business asset at the date of the gift. For example, assume a residential property was bought and immediately let to a tenant. After 5 years the tenant moved out and the property thereafter became a qualifying furnished holiday let. After a further 5 years the property was given away. In this instance, 5/10th of the gain representing the period during which the property was used as a qualifying FHL would be eligible for gift relief. Reed Elsevier UK Ltd 2015 231 FA 2015

However, assume instead that a taxpayer bought a property and used it as a qualifying FHL for 5 years. It was then let to a tenant for 5 years before being gifted. In this case no gift relief would be available because the property was not a qualifying business asset at the date of the disposal. 24.4 Gift Relief on Divorce Assets are often transferred from one party to the other as part of a divorce settlement. If the transfer takes place after the year of separation but prior to the decree absolute, it is treated as a disposal at market value. In addition, a transfer made after divorce under a court order is treated in the same way. Therefore a gain potentially arises on the party making the disposal. If the asset is a qualifying asset it may be possible to make a gift relief claim. However, as we have seen, the amount of gain qualifying for relief is restricted if there is consideration for the transfer. HMRC take the view that, in the absence of a Court order, the transfer takes place in exchange for consideration, being the surrender by the donee of the right to obtain alternative financial provision. This consideration is valued at such an amount as would reduce the gain eligible for gift relief to nil. So in the absence of a Court order no gift relief claim can be made. On the other hand if the transfer takes place under a Court order, the donee is not giving consideration for the transfer and hence a gift relief claim may be made. 24.5 Exchanges of Assets Where two individuals exchange assets, each of them is deemed to have made a disposal of the asset they are getting rid of and a corresponding acquisition of the asset they are now acquiring. Some exchanges involve a straightforward swap of assets. Others involve an exchange of assets plus an additional payment in cash (which is common where the assets being exchanged have different values). The question to address is how to calculate the capital gain. Where there is an exchange of assets between persons who are not connected with each other, the disposal proceeds for CGT purposes are: The value of the asset being RECEIVED; plus Any cash payments received. Illustration 3 Charlotte inherited a painting on the death of her grandmother in 2006. The painting had a probate value of 15,000 and was worth 25,000 in March 2016. Charlotte never liked the painting so in March 2016 she entered into an arrangement with her neighbour Martin (an art collector) under which she exchanged the painting for Martin's car (a Range Rover Sport). The car was valued at 20,000 so Martin paid Charlotte an additional 5,000 in cash. Calculate the chargeable gains arising on Charlotte and Martin, if any, of the disposals of the painting and the car. Reed Elsevier UK Ltd 2015 232 FA 2015

Charlotte has made a disposal of a painting (a chargeable asset). Her gain is as follows: Proceeds: Value of car received 20,000 Cash received 5,000 Total 25,000 Less: Base cost of painting (probate value) (15,000) Gain 10,000 Martin has made a disposal of a car, but this is an exempt asset. Martin has acquired a painting. His base cost for CGT is equal to the proceeds received by Charlotte being 25,000. Where there is an exchange of assets between persons who are connected with each other s.18 TCGA 1992 applies. This section says that the disposal proceeds will be equal to the market value of the asset being DISPOSED OF. Any cash changing hands is ignored. Illustration 4 Alan owns shares in Boardroom Technologies Ltd (an unlisted trading company). He has 100 shares with a base cost of 100,000. In March 2016 he transferred 20 shares to his son Nick. These shares were then valued at 250,000. In return Nick gave Alan a Chinese Vase worth 40,000 and cash of 10,000. Nick had bought the vase at auction for 1,000. Calculate the chargeable gains arising on Alan and Nick, assuming all available reliefs are claimed and state the base cost of the shares for Nick and the vase for Alan. Alan has made a disposal of shares to a connected person. His disposal proceeds are the market value of the shares being 250,000. His gain is therefore as follows: Proceeds 250,000 Less: Base cost (100,000 20/100) (20,000) Gain 230,000 In this case there is a disposal at undervalue of an asset qualifying for gift relief (being the unlisted shares). Therefore, if Alan and Nick jointly elect, part of the gain can be deferred under s.165 as follows: Gain 230,000 Less: S.165 gift relief (200,000) Chargeable gain (50,000 20,000) 30,000 As the donee pays consideration for the asset, the excess of actual proceeds over the donor's CGT base cost is chargeable. Actual proceeds here are 50,000 being the vase plus the cash. Reed Elsevier UK Ltd 2015 233 FA 2015

The base cost of Nick's shares is therefore: Market value at transfer 250,000 Less: S.165 gift relief (200,000) Base cost 50,000 Nick has also disposed of an asset (the Chinese Vase) to a connected person. His disposal proceeds are the market value of the vase being 40,000. His gain is therefore as follows: Proceeds 40,000 Less: Base cost (1,000) Gain 39,000 There is no gift relief here as the vase is not a qualifying asset. The base cost of the vase for Alan is therefore 40,000. 24.6 Exchanges of Interests in Land Special rules exist where two or more people exchange interests in land. Land includes buildings. Where two people jointly own properties and decide to exchange their interests such that each becomes the sole owner of one of the properties, a form of rollover relief applies. TCGA 1992, s.248a This is best illustrated by means of an example. Illustration 5 Karen and her sister Nicola jointly own 2 properties as follows: Cost Current MV Flat in London 50,000 240,000 House in Manchester 100,000 260,000 Each has a 50% interest in the 2 properties. Both properties are let out to residential tenants. For simplicity, we will assume that a 50% interest is valued at one half of the value of the whole property with no tenanted deduction. Karen and Nicola decide to exchange their interests so that Karen will be the sole owner of the flat in London and Nicola will be the sole owner of the house in Manchester. No additional cash payments will be made. Calculate the chargeable gains arising on Karen and Nicola before claiming any reliefs. We take each taxpayer in turn: Karen Reed Elsevier UK Ltd 2015 234 FA 2015

Karen is disposing of a 50% share in the house in Manchester to a connected person. Her disposal proceeds are the market value of a 50% interest in the house in Manchester giving a gain as follows: Proceeds (50% 260,000) 130,000 Less: Base cost (50% 100,000) (50,000) Gain 80,000 Nicola Nicola is disposing of a 50% share in the flat in London to a connected person. Her disposal proceeds are the market value of a 50% interest in the flat in London giving a gain as follows: Proceeds (50% 240,000) 120,000 Less: Base cost (50% 50,000) (25,000) Gain 95,000 Section 248B TCGA 1992 gives roll-over relief on an exchange of land and buildings where: The value of the consideration; Is equal to or less than the market value of the property disposed of. In most cases the consideration will equal the market value and full roll-over relief is available, such that: The chargeable gain will be reduced to nil; and This gain is deducted from the base cost of the asset received. Illustration 6 Continuing with the illustration of Karen and Nicola above, calculate the chargeable gains position for both Karen and Nicola now assuming all available reliefs are claimed. Also state the base costs of the properties going forward. Karen Relief will be available under s.248b TCGA. Karen's chargeable gain will therefore be reduced to nil and the CGT base cost of the new asset will be reduced accordingly. Karen's gain 80,000 Less: Rollover relief under s.248b (80,000) Chargeable gain Nil Reed Elsevier UK Ltd 2015 235 FA 2015

CGT base cost of flat in London: Existing 50% interest (50% 50,000) 25,000 Add: Consideration paid for remaining 50% 50% 240,000 120,000 Less: Rollover relief under s.248b (80,000) 40,000 Base cost of 100% interest in flat in London 65,000 Nicola Relief will be available under s.248b TCGA. Nicola's chargeable gain will therefore be reduced to nil and the CGT base cost of the new asset will be reduced accordingly. Nicola's gain 95,000 Less: Rollover relief under s.248b (95,000) Chargeable gain Nil CGT base cost of house in Manchester: Existing 50% interest (50% 100,000) 50,000 Add: Consideration paid for remaining 50% 50% 260,000 130,000 Less: Rollover relief under s.248b (95,000) 35,000 Base cost of 100% interest in house in Manchester 85,000 Reconciliation If we look at the before and after position, you will see that this reconciles: Karen Nicola Original base costs: (50,000 + 100,000) 50% 75,000 75,000 Revised base costs: Flat in London 65,000 House in Manchester 85,000 Chargeable gains Nil Nil No chargeable gains arise and the aggregate base costs are unchanged Where non-connected persons exchange interests in land, roll-over relief is still available under s.248b. However, in this situation s.18 TCGA 1992 would not apply. Therefore (as we have already seen) when calculating the chargeable gains arising on the exchange, the disposal proceeds for each party will be: The value of the asset being RECEIVED; plus Reed Elsevier UK Ltd 2015 236 FA 2015

Any cash payments received. This consideration will again equal the market value of the asset disposed of and full rollover relief will be available. 24.7 Other Points A claim to roll over the gain on the exchange of interests must be made within 4 years of the end of the tax year in which the exchange takes place. So for an exchange in 2015/16, the claim must be made by 5 April 2020. Relief is not available if the property in which the interest is acquired is the individual's principal private residence. If the property becomes the individual's principal private residence within six years the relief is clawed backed. TCGA 1992, s.248c The situation is slightly different if each of the properties is to be the principal private residence of the respective party. In this case both exchanges are deemed to take place at no gain no loss. TCGA 1992, s.248e Reed Elsevier UK Ltd 2015 237 FA 2015

EXAMPLES Example 1 Steve bought a business asset in 1996 and gave it to his brother Karl in March 2012. A joint claim was made to defer the gain of 20,000. In January 2016, Karl emigrated to Australia. Which of the following statements is true? a. The gain of 20,000 is charged on Steve in 2011/12 b. The gain of 20,000 is charged on Karl in 2011/12 c. The gain of 20,000 is charged on Steve in 2015/16 d. The gain of 20,000 is charged on Karl in 2015/16 Reed Elsevier UK Ltd 2015 239 FA 2015

ANSWERS Answer 1 The answer is D The gain is charged at emigration, i.e. 2015/16, and is charged on the donee, i.e. Karl. If Karl fails to pay the tax within one year, HMRC can collect it from Steve. Reed Elsevier UK Ltd 2015 241 FA 2015