Liber has requested advice on the timing of the sale of the shares which he acquired in a recent company takeover. His sister, Vesta, requires advice on the tax consequences of making a lifetime gift, rather than leaving an asset in her estate upon her death.
Liber:
– Is UK resident and domiciled.
– Has taxable income of £30,000 each year.
Liber – acquisition of ordinary shares in Mercury plc:
– Liber purchased 800 ordinary shares (a 40% holding) in Vulcan Ltd for £14,000 on 1 July 2008.
– Mercury plc acquired 100% of the ordinary share capital of Vulcan Ltd on 1 June 2018.
– In exchange for each ordinary share in Vulcan Ltd Liber received the following:
– Four ordinary shares in Mercury plc valued at £20 per share immediately after the takeover; and
– £15 cash
– Mercury plc has 200,000 issued ordinary shares.
– Liber has never been a director or employee of either Vulcan Ltd or Mercury plc.
– The takeover was for bona fide commercial reasons and not for the avoidance of tax.
Liber – proposed transaction in Mercury plc shares:
– Liber now wishes to sell all of his shares in Mercury plc.
– He has received an offer from an unconnected person to purchase these shares on 1 January 2019 at a price of £28 per share.
– Liber would prefer to sell the shares to his nephew, Janus. However, this would delay the sale as his nephew will not have the necessary funds to purchase the shares until 1 May 2019.
– Janus has said he will also pay £28 per share.
Vesta:
– Is 66 years old and has never married or had a civil partner.
– Is in ill-health and is expected to die at some time within the tax year 2019/20.
– Has made no disposals for capital gains tax purposes in the tax year 2018/19 to date and will not make any in the tax year 2019/20.
– Has made one previous lifetime gift, of £350,000 cash, to her son, Janus, on 1 June 2018.
Vesta – investment property:
– Vesta owns an investment property, which has never been used as her principal private residence.
– The current market value of the property is less than the price Vesta paid for it, and its value is expected to fall further throughout the tax year 2019/20.
– Vesta is considering gifting the investment property to Janus in her lifetime, rather than leaving it to him in her estate on death.
– Janus is the sole beneficiary of Vesta’s estate.
Required:
(i) Explain, with supporting calculations, the capital gains tax implications for Liber of the takeover of Vulcan Ltd by Mercury plc on 1 June 2018, and a subsequent sale of his Mercury plc shares on 1 January 2019.
(ii) Explain, with supporting calculations, why it would be beneficial for Liber to sell his Mercury plc shares on 1 May 2019, instead of on 1 January 2019.
Liber
(i) Capital gains tax implications of the takeover of Vulcan Ltd on 1 June 2018 and a subsequent sale of the Mercury plc shares on 1 January 2019
Gain on the cash received in the takeover
The share-for-share exchange rules will automatically apply on the takeover of Vulcan Ltd on 1 June 2018, as this was a bona fide commercial transaction, and Mercury plc has acquired more than 25% of the ordinary shares in Vulcan Ltd. The shares in Mercury plc will ‘stand in the shoes’ of the shares in Vulcan Ltd and no gain will be chargeable in respect of these shares until they are sold. The receipt of cash is treated as a part-disposal of the Vulcan Ltd shares and a chargeable gain will arise at the date of the takeover.
The chargeable gain in respect of the cash received is £9,789 (£12,000 – £2,211 (W)).
Entrepreneurs’ relief will not be available in respect of the gain arising on the cash consideration, as Liber was not a director or employee of Vulcan Ltd.
Gain on the sale of the Mercury plc shares
Entrepreneurs’ relief will not be available on the sale of the Mercury plc shares as Liber is not a director or employee of Mercury plc, and holds less than 5% of the ordinary shares in Mercury plc.
Tutorial note: Where there is a share-for-share exchange, the 12-month ownership requirement includes the holding period of the original shares.
Capital gains tax (CGT) payable is £14,910 (((£33,500 – £30,000) x 10%) + ((£76,300 – £3,500) x 20%)).
Working: Allocation of cost at time of takeover
(ii) Reasons why it is beneficial to sell the Mercury plc shares on 1 May 2019 instead of on 1 January 2019
The calculation of the gain on the sale of the Mercury plc shares will be the same, but the sale will be in the following tax year, 2019/20, so the following tax implications will arise:
The gain on the cash received on the takeover in 2018/19 will be covered by the annual exempt amount for that year and so there will be no CGT liability in 2018/19.
The whole of the 2019/20 annual exempt amount will be available to be deducted from the gain on the sale of the Mercury plc shares. This will result in a CGT liability of £12,952 in 2019/20 (W). The overall tax saving if the Mercury plc shares are sold on 1 May 2019 is therefore £1,958 (£14,910 (as in (a)(i)) – £12,952).
Tutorial note: Alternatively, delaying the sale of the shares until 1 May 2019 results in the gain on the cash received in the takeover of £9,789 being fully covered by the annual exempt amount for 2018/19 and therefore a CGT saving of £1,958 (20% x £9,789).
The tax relating to the sale of the Mercury plc shares will be due a year later on 31 January 2021, rather than 31 January 2020
Working: CGT liability if Mercury plc shares disposed of on 1 May 2019
Advise Vesta whether or not there are any capital gains tax or inheritance tax advantages, for herself, or for Janus, if she were to gift the investment property to Janus on 31 December 2018, rather than leaving it to him in her estate on death.
Vesta
Capital gains tax and inheritance tax advantages of gifting the investment property on 31 December 2018
Capital gains tax (CGT)
If the property remains in Vesta’s estate on her death, there will be no CGT implications, such that the fall in value of the property will not give rise to an allowable loss.
If the property is gifted to Janus on 31 December 2018, an allowable loss will arise as a result of the fall in value. However, as Vesta will make no disposals for CGT purposes in 2019/20, she will not be able to relieve this loss.
Therefore, for CGT purposes, Vesta will be indifferent as to whether to gift the property to Janus in her lifetime, or to leave it to him in her estate on death.
However, Janus’s base cost of the property on a future disposal is its market value at the date it is transferred to him. Accordingly, as the property is expected to be worth less at the date of Vesta’s death than it is currently, it will be advantageous from Janus’s point of view if Vesta gifts the property to him on 31 December 2018 as he will then have a higher base cost for CGT purposes on a future sale.
Tutorial note: As Janus and Vesta are connected persons, the CGT loss on the gift of the property to Janus on 31 December 2018 could only have been relieved against a gain arising on a later disposal by Vesta to Janus.
Inheritance tax (IHT)
If the property remains in Vesta’s estate at the date of her death, it will be included at its value on death, which is expected to be lower than its current market value.
If the property is gifted to Janus on 31 December 2018, it will be a potentially exempt transfer (PET), such that there will be no immediate charge to IHT. This PET will become chargeable as a result of Vesta’s death within seven years.
As the value of the property is expected to have decreased between the date of the gift and the date of death, fall in value relief will be available (assuming that Janus still owns the property, or has sold it in an arm’s length transaction), so the lifetime gift will not result in any more IHT being payable on the property than if it were left to Janus in the death estate.
No annual exemptions are available as they have been used on the cash gift to Janus on 1 June 2018.
No taper relief will be available as Vesta will not have survived for three years after making the gift.
Therefore, for IHT purposes, both Vesta and Janus will be indifferent between a lifetime gift and leaving the property in her estate on death.