John Riches and Sophie Dworetzsky on ways in which lower asset valuations are opening up some attractive tax-planning possibilities
Taking stock can be an illuminating exercise. This time last year tax advisers in the UK were breathing a collective sigh of relief that tax year-end had passed and they had (just) survived.
The activity in the run-up to 6 April 2008 was incredibly frenetic, in no small part as a result of the widely debated changes to the remittance rules and the treatment of UK-resident non-domiciles, which have now been enacted.
Another key component was the end of taper relief, and the overhaul of capital-gains tax to a flat 18 per cent rate. There was huge focus on ensuring that offshore gains were brought onshore at the best rates, or that onshore gains were triggered before taper relief was abolished, as the case may be.
The world today is a very different place. The global downturn has cast a long shadow, significant value has been wiped off investments, and talk of planning for gains has a slightly surreal, Alice in Wonderland feel in today’s environment.
Surprisingly, though, there is a silver lining to be found in reduced asset values, in the form of tax-planning possibilities, if careful strategies are put in place now.
Reduced asset values mean that now is a very opportune time to undertake lifetime gifting to family members or others. Typically, a gift of assets triggers a charge to CGT at 18 per cent. Where the asset is standing at a loss the gift can be made on a CGT-neutral basis, and also crystallises the loss to be potentially carried forward.
With careful planning one can ensure maximum benefit is realised from losses crystallised on gifts to family members, for example by gifting assets standing at matching losses and gains.
For UK inheritance tax (IHT) purposes, gifts are typically free of IHT provided that the donor survives seven years after the gift. Venturing beyond tax, a controlled gift is frequently preferable where the recipients are young, there is concern about asset protection or predators or a desire to ensure longer-term family benefits accrue from the gift.
Historically trusts provided an attractive solution in addressing these concerns, although following the changes to the IHT rules for trusts enacted in 2006, many lifetime transfers into trusts are now subject to IHT at 20 per cent, with an additional ten-yearly charge of 6 per cent on the value of the fund.
An attractive and tax-efficient alternative involves gifting assets to family members through a family limited partnership (FLP). This structure has long been employed in the US and is now being used with ever greater frequency in the UK, and permits controlled gifts to be made to family members without the IHT charges that now apply to trusts.
Gifts within an FLP will crystallise a capital loss in the same way as a direct gift, and can also be crafted to give the donors continuing income rights or interests.
Trusts remain worth considering in some circumstances, notably where shares in trading family businesses are in point, as reliefs such as business property relief (BPR) can apply so that the transfer can be made without triggering IHT charges.
While the ability to hold over gains on gifts into trusts has been restricted, this may be of little relevance if the shares are standing at a loss or minimal gain. Even in these cases it is important to consider the longer-term intention, as a future sale of the shares can mean that IHT charges apply to the trust fund on an ongoing basis.
One positive aspect of the changes to the remittance rules is that UK-resident non-domiciles are now able to make use of their offshore losses. Previously, offshore losses could not be offset against onshore gains. That has now changed, and, in some cases, offshore losses incurred by non-domiciles can be offset against onshore gains.
This is not automatic and requires that an election be made. There are important timing issues surrounding the election: if it is not made in the first year for which the remittance basis is claimed, the right to make the election is lost for ever.
Relevant considerations in deciding whether to make the election include the order in which offshore losses are available. Essentially they may be set against offshore gains which are remitted and not remitted, with the benefit of the loss becoming relevant when the gain is remitted.
UK gains are relieved by offshore losses only after all offshore gains have been offset. Given the need to make an election, and the associated disclosure requirements, non-domiciles will wish to consider the relative merits of making the election or not, weighing potential benefits against potential disclosure considerations.
It may be that where there are significant offshore gains which may never be remitted the election is less attractive, but this needs to be thought about on a case-by-case basis.
For the right client, though, the capacity to set offshore losses against remitted and onshore gains may prove very helpful, and it will be important to ensure the opportunity is not lost given the strictures applying to the election.
Gains realised within non-UK-resident trust structures can no longer be received onshore by non-domiciled beneficiaries tax-free, unless they are pre-5 April 2008 gains. Essentially, going forward, all post-5 April 2008 gains received onshore by UK-resident non-domiciled beneficiaries will be matched with trust gains, and chargeable accordingly.
The concept of the rebasing election, though, permits trustees effectively to divide trusts into pre- and post-5 April 2008 pots, so that gains realised on assets held as at 5 April 2008 may be received onshore under the old rules.
Where a gain realised on an asset contains pre- and post-5 April 2008 elements, only the element relating to the later period will trigger a charge to CGT if received onshore. Again, there are disclosure considerations associated with making a rebasing election.
Trustees will wish to consider the tax advantages of making an election as against the disclosure requirements, and in cases where there is no intention to remit from the trust there may be fewer advantages in the election, though bearing in mind the importance of retaining flexibility to remit tax efficiently in future, should circumstances change.
Trustees will need to pay close attention to the occurrence of trigger events that start the clock running on the time-frame for making the election, as if it is not made within a set time after a trigger event, the ability to make the rebasing election is lost.
Where a loss is realised on the disposal of assets within an offshore trust, it can reduce the trust gains, and to maximise the benefits of losses in reducing trust gains trustees will wish to play close attention to the timing of selling assets held within trust holding companies, to seek to ensure that matching gains and losses are realised in the same year.
In summary, and rather surprisingly, present economic conditions do offer a silver lining, and now is an opportune time to review matters carefully and implement lifetime planning, as well as a time for non-domiciles to ensure they make full use of the beneficial changes hidden in the detail of the changes to the remittance basis.
So while the world is a very different place today, careful tax planning can maximise benefits to be had from the downturn and could be said to be more imperative when reviewing options.
John Riches is a partner in the Wealth Planning department at Withers and head of STEP’s public policy committee. Sophie Dworetzky is a partner in Wealth Planning at Withers