The tax implications of making Gifts

You are planning to make gifts to your children to reduce the inheritance tax (IHT) burden for your estate. But to achieve this you’ll either need to sell assets to raise the cash or gift them. But how does any resulting capital gains tax (CGT) impact on IHT planning?  Partner and Tax expert Kenny Adamson looks at the options and the implications.

The changes to the inheritance tax (IHT) regime announced in the Autumn 2024 Budget will bring many more estates within the scope of the tax. The easiest way to reduce IHT on your estate is to make gifts during your lifetime instead of through your will. However, if you don’t have the cash available you can give away assets instead or sell them and give away the proceeds, but this can have other tax consequences.
Selling or transferring investments such as unit trusts, shares and property may mean you have to pay capital gains tax (CGT) on some of the proceeds.

IHT and gifts
As indicated above, the CGT position can differ depending on whether you give away cash or assets, the result is the same for IHT purposes. After seven years from when you make a gift it escapes IHT. Until then it is a “potentially exempt transfer” (PET). A PET isn’t liable to IHT at the time it’s made, it only becomes chargeable if you die within the following seven years.

If you die more than three years but less than seven after making a PET, any resulting IHT is reduced. The longer you survive beyond three years the less IHT is payable.

Interaction of IHT and CGT
While the two taxes are entirely separate, CGT can have an indirect effect on IHT.

EXAMPLE Brian’s estate exceeds the IHT nil rate band (the amount on which no IHT is payable) by £600,000. He transfers assets worth £400,000 to his two children. This results in a CGT bill of £48,000. The reduction in Brian’s estate is therefore £448,000. If Brian survives seven years from when he made the gifts the IHT saving will be £179,200 but at the cost of £48,000 in CGT, making the net tax saving £131,200. If instead Brian was able to give away assets on which no CGT is payable, the full £179,200 is saved.

Combined tax planning
As our example above shows, CGT can negatively impact IHT planning. Therefore, to improve tax efficiency you should follow a few rules.

• Where possible make gifts from cash savings, but don’t leave yourself short.
• Make gifts that are exempt from IHT before making PETs.
• If you need to sell or transfer assets to make gifts, choose those that will result in the least CGT, i.e. assets that have increased in value least since you acquired them.
• Use your CGT annual exemption every year if possible. This can reduce the CGT bill when selling or transferring an asset to fund a gift.
• Finally, the golden rule, make gifts as soon as you can afford to as this increases the chance of a PET becoming fully exempt from IHT.

IN SUMMARY
While any CGT payable as a result of making a gift reduces your estate, and thus potentially the IHT, it increases the combined tax cost. Therefore, to improve tax efficiency, and if possible, give away or sell assets that will result in little or no CGT. You can use your annual CGT exemption to help achieve this.

Contact the JRW Hogg & Thorburn team to discuss this further and any other related questions you may have.