Adam would like advice on the capital gains tax and inheritance tax implications of being given Eastwick Farm by his mother, Sabrina, and on recent changes in tax law which affect his investment planning.
Sabrina:
– Is UK resident and domiciled.
– Has made one previous lifetime gift of £350,000 into a discretionary trust for her grandchildren on 1 September 2017.
– Inherited Eastwick Farm from her husband, Sam, on his death on 1 July 2016.
– Has managed the farm since this date.
Sam:
– Owned and farmed Eastwick Farm for many years prior to his death on 1 July 2016.
– Had made lifetime gifts which used the whole of his nil rate band for inheritance tax purposes.
Sabrina – proposal to gift Eastwick Farm to Adam:
– Sabrina plans to retire from running the farm on 31 December 2017.
– She has been informed by a financial adviser that she could gift the farm to Adam when she retires without paying any capital gains tax or inheritance tax.
– She has decided to gift the farm to Adam on 1 January 2018.
Eastwick Farm – valuation of land and buildings:
1 July 2016 1 January 2018
(estimated)
£ £
Agricultural value 385,000 396,000
Market value 502,000 544,000
Adam:
– Is UK resident and domiciled.
– Is 42 years old.
– Is an additional rate taxpayer, with adjusted income (for the purpose of calculating Adam’s annual allowance for pension contributions) of £200,000 per year, which he expects to continue for the foreseeable future.
– Uses his annual exempt amount for capital gains tax purposes each year.
– Is in full-time employment and will lease Eastwick Farm to a tenant farmer.
Adam – investments:
– Adam has regularly contributed £40,000 into a personal pension scheme to use his annual allowance.
– Adam has invested the maximum amount each year in an individual savings account (ISA).
Adam – thoughts on investments:
– ‘I have been advised that my annual allowance for pension contributions was reduced to £15,000 for the tax year 2016/17, so I have incurred an additional tax charge. Please can you explain this reduction in my annual allowance?’
– ‘Is there now any point in investing in either a cash or a stocks and shares ISA as savings income and dividends are now exempt from tax anyway up to £5,000 per year?
Required:
(i) Explain the capital gains tax and inheritance tax implications for Sabrina of the planned gift of Eastwick Farm to Adam on 1 January 2018, and the reasons why the financial adviser has determined that neither tax may be payable by her as a consequence of this gift.
Note: Detailed calculations are NOT required for this part.
(ii) Explain, with supporting calculations, Adam’s potential capital gains tax liability on a future sale of Eastwick Farm and the inheritance tax implications for him of being gifted the farm by Sabrina on 1 January 2018 if, as he intends, he leases the farm to a tenant farmer, and Sabrina dies before 1 January 2025.
Sabrina and Adam
(i) Implications for Sabrina of the gift of Eastwick Farm to Adam on 1 January 2018
Capital gains tax
On the gift of the farm to Adam, chargeable gains will arise on the chargeable assets gifted. These will be computed by reference to the market values of the assets at the date of the transfer, i.e. 1 January 2018. Their base costs will be their market values at the date of Sam’s death, i.e. 1 July 2016.
However, gift relief will be available as this is the gift of a business, and the financial adviser has assumed that this will be claimed. As no proceeds will have been received from Adam, the whole of the gain can be deferred, such that Sabrina will have no liability to capital gains tax.
Inheritance tax
The gift will be a potentially exempt transfer, so Sabrina will have no liability to inheritance tax.
(ii) Implications for Adam of the gift of Eastwick Farm on 1 January 2018
Capital gains tax
The claim for gift relief is a joint claim by both the donor and donee, so Adam will have to agree to this
If the claim is made, the chargeable gains on the gift of the farm of £42,000 (£544,000 – £502,000) will be deferred. Adam’s base cost in each of the assets will be their market value less the chargeable gain on the gift. Accordingly, if a claim for gift relief is made, Adam’s chargeable gain on the future disposal of any or all of these assets will be greater.
If Adam leases the farm to a tenant farmer, entrepreneurs’ relief will not be available on any subsequent disposal, as the farm will be an investment for Adam; he will not be carrying on a business. As Adam will be an additional rate taxpayer, this will generate an additional capital gains tax liability of £8,400 (£42,000 x 20%).
Inheritance tax
The gift of the farm by Sabrina on 1 January 2018 will qualify for agricultural property relief (APR) at the rate of 100% on the agricultural value on 1 January 2018 of £396,000. Sabrina has been managing the farm since her husband’s death and although she has owned the farm herself for less than two years, as she inherited it from her husband on his death, his period of ownership can be added to hers, such that the two-year holding period is satisfied.
The excess of the market value over the agricultural value on 1 January 2018 of £148,000 (£544,000 – £396,000) is eligible for business property relief (BPR) at the rate of 100%, because Sabrina, as owner, has been farming the land herself, and, as above for APR, the two-year ownership requirement is satisfied.
In the case of Sabrina’s death before 1 January 2025, i.e. within seven years of making the transfer, it is important that Adam still owns the farm at the date of her death. This is because, provided the farm still constitutes agricultural property, i.e. it is used for agricultural purposes by the tenant to which it is let, APR will be available on the agricultural value.
However, as Adam is not intending to farm it himself, no BPR will be available on Sabrina’s death. Accordingly, the £148,000 excess of the market value over the agricultural value of the farm will be liable to inheritance tax at the rate of 40%. Sabrina’s annual exemptions for 2017/18 and 2016/17 and her nil rate band have been used on the earlier transfer into the discretionary trust.
Adam will therefore have a maximum potential inheritance tax liability of £59,200 (£148,000 x 40%).
Taper relief will be available to reduce this amount if Sabrina survives until at least 1 January 2021 (three years after making the gift).
Any inheritance tax payable by Adam will be deductible when computing the chargeable gain arising on a subsequent disposal of the farm (but cannot be used to create an allowable loss).
Comment on the thoughts expressed by Adam in relation to his personal pension contributions and investment in individual savings accounts (ISAs).
Personal pension scheme
As Adam’s adjusted income exceeds £150,000, his annual allowance for obtaining tax relief on pension contributions has been reduced with effect from the tax year 2016/17. There is a reduction of £1 for every £2 of income in excess of £150,000. As Adam’s adjusted income is £200,000, this has reduced the annual allowance by £25,000 ((£200,000 – £150,000)/2), leaving an annual allowance of only £15,000 (£40,000 – £25,000).
Individual savings accounts (ISAs)
Adam’s thoughts are only partially correct
The first £5,000 of dividend income is exempt from income tax each year, but any dividends in excess of this will be taxed at Adam’s highest marginal rate of tax, which, as an additional rate taxpayer, would be 38·1% on the excess dividends over the higher rate threshold.
If he is considering investing in stocks and shares, he needs to consider his current and potential future level of dividends. If these use his £5,000 nil rate band, a stocks and shares ISA, under which all dividends are exempt from income tax, is still worthwhile.
He should also remember that the disposal of investments within a stocks and shares ISA is exempt from capital gains tax. This will be particularly relevant to him if he continues to use his annual exempt amount each year.
Adam is incorrect in relation to savings income. As an additional rate taxpayer, Adam has no entitlement to the savings nil rate band, so all his savings income will be taxable. If Adam wishes to hold money in cash deposits, then a cash ISA will still be beneficial.