James Bailey looks at ways in which you can gift property investment company shares bearing in mind your capital gains tax and the recipient’s inheritance tax position.
If you want to pass on your property investment company to your children, you are faced with a problem, because such shares do not qualify for capital gains tax (CGT) holdover relief. You could be charged to CGT as if you had sold the shares for their market value.
One possibility is the use of a discretionary trust – the details are beyond the scope of this article – which will allow you to make gifts up to your ‘nil rate band’ for inheritance tax (IHT) purposes (currently £325,000) every seven years. If you transfer more than £325,000 of value, you will have to pay IHT at the ‘lifetime rate’ of 20% on the excess. This is because a gift to a trust is a ‘chargeable transfer’ for IHT – and that is why you are allowed to hold over the capital gain.
Valuing gifts
Gifts are valued differently for IHT and CGT. For CGT, the gift is the value of the asset given away, but for IHT, the value transferred is measured by how much the giver’s estate has reduced. This may sound like a distinction without a difference, but when it comes to shares in an investment company, the difference becomes very real and potentially expensive.
For example, if a company is worth £1 million, how much would you pay for a 10% stake in it - £100,000? Think about it – as a 10% shareholder, you have very little influence over how a company is run, you can be outvoted, and you have no influence over when dividends are paid. The conventional wisdom is that you would only be prepared to pay about 15% to 25% of the proportionate value – between £15,000 and £25,000.
Different discounts apply to different levels of shareholding. A crucial difference is that between 49% of the shares and 51% of the shares, for obvious reasons – if you own 51% of the shares, you can control what the company does in most (but not all) situations. For our £1 million company, a 51% shareholding might be worth £459,000 (a discount of 10%), but a 49% shareholding would only be valued at around £245,000 (a discount of 50%). This discount could be larger – for example, if all the other shares are held by one individual – and a 49% holding could be worth as little as £147,000 (a discount of 70%).
A valuation trap
Given that the value transferred to a discretionary trust will be measured in the IHT style – not what the recipient received, but what the giver lost – care is needed when valuing the gift to be given, because if you exceed your nil rate band of £325,000, you will be faced with an immediate charge to IHT at the ‘lifetime rate’ of 20%.
Example – The over-generous gift
Mr Scrooge owns all the shares (1,000) in a property letting company, which is valued at £1,000,000. He wants to pass on the company to his son and sets up a discretionary trust, to which he gives 325 shares, reasoning that if the company is worth £1 million, then each of the 1,000 shares is worth £1,000 and he is exactly within the £325,000 limit.
In fact, the calculation goes like this:
Value of 100% holding before the gift £1,000,000
Value of 67.5% holding after gift (20% discount) £540,000
Transfer of value for IHT £460,000
IHT (£460,000 - £325,000 = £135,000 @ 20%) £27,000
By forgetting the principle that the IHT value transferred is the value he loses, not what his son gains, Mr Scrooge has let himself in for an unpleasant and costly surprise.
Practical Tip:
When making gifts of shares in an investment company, remember how these discounts work and seek the advice of a specialist in valuing shares, to ensure your gift does not trigger an unexpected liability to IHT.
