Family tax planning exercises involving the transfer of assets between spouses (or civil partners) is often necessary to enable each spouse to fully utilise the various tax exemptions available to an individual. If one spouse owns all the family assets this would not be possible. The ability to make such transfers tax effectively is thus important.
Equalisation of Estates
As a general rule so-called “equalisation of estates” is desirable. This means that ideally each spouse should own assets amounting to at least the value of the inheritance tax (IHT) nil rate band (£325,000 for tax year 2010/11); own assets which, on sale, enables full use of the capital gains tax (CGT) annual exempt amount (£10,100 for tax year 2010/11) and own assets generating income sufficient to mitigate any exposure to higher rate income tax.
The transfers between spouses must be “real” transfers and effected as if to a third party. This means all relevant documentation must be correctly completed.
For IHT purposes inter-spouse transfers are “exempt” transfers and thus not subject to IHT if the spouses are married, although not necessarily living together. As indicated above, transfers from one spouse to the other to ensure each spouse’s estate is at least £325,000 can thus be made without attracting any inheritance tax charges.
UK and Non-UK Domiciled Spouses
There is one caveat to the application of the above exemption. Any transfers from a UK domiciled to a non-UK domiciled spouse are only exempt up to the first £55,000; above this amount the transfers constitute potentially exempt transfers and death of the transferor spouse within seven years may precipitate an IHT charge.
Despite the risk associated with an inter-spouse transfer to a non-UK domiciled spouse, such transfers enable overseas property (e.g. Spanish holiday villa), otherwise subject to IHT, to then qualify as “excluded property” which is not subject to IHT.
Capital Gains Tax
Although inter-spouse transfers are not technically exempt from CGT the mechanics of computation are such that no CGT charge arises on such transfers. This treatment requires the spouses to be married and living together.
H acquired shares worth £10,000. He transfers them to W when they are worth £15,000, realising a potential capital gain of £5,000. However, as the transfer is inter-spouse the assumption is that the shares are transferred at a value of £10,000.
Thus, H realises no capital gain and W is deemed to have acquired the shares at a cost of £10,000. Should W sell at a later date for £17,000, her capital gain will be £7,000.
The annual exempt amount of £10,100 cannot be carried forward if unutilised (i.e. is lost); it is therefore important wherever asset disposals are to be made that each spouse utilises their exempt amount which may require inter-spouse transfers to be made prior to sale.
Although inter-spouse transfers can generally be carried out tax effectively, an inter-spouse transfer of an interest in the family or holiday home can be problematic.
H has owned a holiday home for 10 years which is not the family’s main residence. The family are selling their main residence and intend to move into the holiday home. H gives 50% of the holiday home to W.
If H gives the 50% to W just prior to moving in, this enables the whole of any capital gain on a future sale attributable to W’s interest to be free of CGT. However, if H gives the 50% after moving in, W is assumed to have acquired her 50% interest on the date H originally purchased it. The effect of this is that on a future sale by W, her capital gain will not be free of CGT as her period of ownership includes the first ten years when the holiday home was not her main residence.
The important point to note is that the timing of inter-spouse transfers of property interests (in the main home or holiday home) may worsen the overall CGT position and thus in certain cases should not be made.
A 20% saving of income tax can often be achieved by ensuring income producing assets (e.g. shares & buy-to-lets) are held jointly. An asset may be held 99%/1% for CGT purposes yet income on it split 50%/50%.