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The delicate subject of death-related tax planning is explored by MIKE THEXTON MA, FCA, CTA, director, Thexton Training Ltd. TAX PLANNING INVOLVING death is always a tricky subject. There are a number of traps to fall into which can make the sad event even more unpleasant. There are also a number of opportunities, which tax advisers cannot be seen to press too enthusiastically, in case they are suspected of being in cahoots with the funeral directors. Planning for death is a sombre business; plans which use death seem a little distasteful.
The delicate subject of death-related tax planning is explored by MIKE THEXTON MA, FCA, CTA, director, Thexton Training Ltd. TAX PLANNING INVOLVING death is always a tricky subject. There are a number of traps to fall into which can make the sad event even more unpleasant. There are also a number of opportunities, which tax advisers cannot be seen to press too enthusiastically, in case they are suspected of being in cahoots with the funeral directors. Planning for death is a sombre business; plans which use death seem a little distasteful. Nevertheless, people are sometimes keen to make sure that if they cannot take it with them, they do not leave it behind for the Inland Revenue. So tax advisers should be aware of the various opportunities, as well as the necessary communication skills to put them tactfully before their clients. One plan which has been around for years runs as follows. It works whichever spouse dies, but to avoid confusion let us suppose that a husband has been given a short time to live, and his wife has substantial assets with substantial capital gains in them. Both are domiciled within the United Kingdom. The plan is simple: she gives her assets to him; he dies, and leaves them to her. Both gifts are free of inheritance tax; her gift to him is at a no loss, no gain price for capital gains tax, and his legacy back to her is at probate value, without a charge to capital gains tax. So all the gains have disappeared. Better still (possibly!), the capital gains tax records have been simplified at a stroke. What previously was a history stretching back through 30 years of mergers, demergers, scrip dividends and rights issues has become a single, simple acquisition of shares at probate value on the date of the husband's death. Never mind how much tax is saved, think of the time saving. Could this be a 'main benefit other than the avoidance of tax' which might turn unacceptable tax avoidance into acceptable tax mitigation? In any case, it is very hard for the Revenue to argue that any sequence involving the death of one of the parties is 'a pre-ordained series of transactions entered into only for a tax benefit'. Although there must be an Inspector Morse story (or similar) in which the wife gives all her assets to her husband, he subsequently declares that he is feeling much better, and goes off with his secretary (or the milkman). This is followed by his mysterious demise, before he has had the chance to change his will. If there is no such story, I must get around to writing it. Please do not take advantage of this foolish disclosure of most of the plot … The hoped-for tax benefit is set out in Example 1.
Example 1
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The wife's share portfolio has been built up over 30 years, and is estimated to have a base cost of about £200,000, including indexation up to April 1998. |
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The market value at the date of gift is perhaps £450,000. It is estimated that by the time of the husband's death, the market value may have declined a little, perhaps to £430,000 (the Stock Market being what is currently is). |
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The capital gain of £250,000 (or £230,000) disappears from any possibility of a charge to capital gains tax; the portfolio has a single acquisition date on the husband's death, and a base cost of £430,000. Taper relief will start to run from that date. There is no need for any significant capital gains tax calculations, because whatever the base cost was, it will be the no loss, no gain price, and the Revenue ought to agree that it does not need to be calculated in detail. |
A catch
But what happens if the husband dies more quickly than expected? This is a situation that has recently happened in practice (proving that people actually do enter into these plans, and they are not simply an exercise in bad taste put about by tax lecturers). The husband died just three weeks after the gift from his wife. This means that, for capital gains tax purposes, the wife gets the shares back within 30 days of the disposal. Bed and breakfasting rules apply. The disposal of the shares is matched with the subsequent reacquisition, and the wife's portfolio still has its original base costs. This seems very unfortunate, and it is tempting to try to find a reason for the rules not to apply. There seems to be no reason which works in all circumstances. The identification rules were changed in 1998 mainly to deal with the deliberate sale and repurchase of shares, which usually took place overnight, but 'deliberateness' is not required, nor is a sale and repurchase. The Revenue's comments on the operation of the bed and breakfasting rules in Tax Bulletin, April 2001, confirm its view that in this situation (although not specifically described in this article) the original shareholding is deemed to be held throughout the period by the original owner.
A possible rescue?
The fact that the base cost is not uplifted appears unfortunate (not, perhaps, as unfortunate as the husband's very untimely death; it is necessary to retain a sense of proportion). However, a different tax benefit appears to arise, as shown in Example 2.
Example 2
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The wife's portfolio is disposed of to her husband at a no loss, no gain price. Let us now say that this can be calculated accurately as £200,000, including indexation. So, on the date of the gift, the disposal value is set at £200,000 by section 58(1), Taxation of Chargeable Gains Act 1992. |
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This must now be matched with the acquisition from the husband, which is fixed at probate value of £430,000 by section 62(1). The no loss, no gain rules do not apply to the disposal on death, so that is the acquisition cost for the bed and breakfasting transaction. |
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There appears to be an allowable loss of £230,000, being the difference between the disposal value of £200,000 on the date of gift, and the acquisition cost three weeks later of £430,000. That loss would be as good as, possibly better than, the uplift in base cost. |
Unfortunately, it is an illusion. Although it seems rather unfair, the no loss, no gain provisions in section 58(1) will revise the disposal value on the date of gift to whatever the acquisition cost is deemed to be. If the identification rules say that the shares disposed of are the old portfolio, the section 58(1) value is £200,000; if the identification rules say that they are the legacy, the value is £430,000. There cannot be a gain or loss on the disposal between husband and wife. The acquisition by the wife on death is not a no loss, no gain transaction, but that is not the problem. The disposal by the wife cannot create a loss.
Capacity
The only possible line which could stop the identification is the argument that the shares were not actually reacquired by the wife until they were distributed to her by the personal representatives. It would be possible for the personal representatives to sell the shares and distribute cash to the wife, in which case she never reacquires the shares. The tax benefit would surely accrue as planned. What if she is the personal representative? The shares will vest in her immediately after the death, so she appears to reacquire them within 30 days. However, she could argue that she holds them in a different capacity from her previous beneficial ownership, because the personal representative acts for the beneficiaries of the estate as a whole (section 62(3)). Again, she could sell the shares out of the estate and distribute cash to herself, and it seems that bed and breakfasting could not apply to her. What if the widow is the personal representative and sole beneficiary of the estate? There is then an argument that the shares vest in her immediately and she is the beneficial owner, so she would not be acting in a different capacity from herself personally. However, section 62(3) appears to require that the personal representatives are always treated as separate from real people for the duration of the administration of the estate, just as trustees are (although section 62(3) is not quite as emphatic about it as section 70 is for trustees). If the widow (or any other executor) distributes the shares to herself, her intermediate ownership as personal representative is then ignored for capital gains tax, and legatees are regarded as acquiring the assets on the date of death (section 62(4)). Although the rules might not be triggered until the winding up of the estate, long after the 30 days have expired, it is likely that they would operate once the shares were distributed. The investment manager's software is very likely to apply them, if the death-day is put in as the acquisition date.
Another catch
There is a further catch-22 here. It is well known that realised capital losses are of little use to a personal representative: they cannot be transferred to beneficiaries (unlike trust losses, which still can be transferred in some circumstances, in spite of increasing restrictions to counter avoidance plans). If the personal representatives have unused capital losses at the end of the administration period, those losses will vanish. Accordingly, if the personal representatives have assets standing at a capital loss, and the capital loss would be useful to someone else, the normal plan is to appropriate the asset to the beneficiary in satisfaction of a legacy before the asset is sold. For this to work, however, no inheritance tax should be payable; there would be different considerations if one of the post-death sale inheritance tax reliefs was available. The loss then accrues to the beneficiary, rather than to the personal representatives. But this would have the effect of denying any benefit of the gift-and-legacy-back plan, the personal representatives should sell the shares and distribute cash. They will still have a better capital gains tax treatment, in spite of realising a useless loss. What if the shares were in joint names? They would simply pass to the widow by survivorship. In either case, there is a strong argument that the bed and breakfasting rules apply immediately. As survivor, she acquires the shares in her personal capacity, not as the personal representative.
Complications in the records
Suppose the wife did not give all her shares to her husband, and then receives the gifted shares back from the personal representatives six months after his death. The records have to register her acquisition of the shares as at the date of death, and bed and breakfasting will apply retrospectively. This leads to the potential problem that she could have made other disposals in the meantime out of the shares that she retained, and she then has to insert an acquisition which is deemed to take place before disposals that have already been accounted for. However, this is a common situation with takeovers, employee share schemes and legacies, and the records simply have to cope with it.
Anything else?
So, because the husband died within 30 days of the gift from his wife, the hoped-for capital gains tax advantage has evaporated. Is there anything left? In section 58(2)(b), the no loss, no gain rule is stated not to apply to a gift donatio mortis causa. This is defined as 'a gift of personal property made in contemplation of the conceived approach of death' (see Duffield v Elwes Ch D 1827). Sadly, it has to be the contemplated death of the donor; otherwise this plan would fit the definition! In summary, a pitfall comes with this plan. If the gift is made within the 30 days leading up to the death, and the subject of the gift is shares, and the shares are returned to the original owner, then there will be no capital gains tax saving, and no simplification of the capital gains tax records. It is only necessary to knock out one of those three conditions, and the plan works: Raising the subject of death-related tax planning with the client in the first place is hard enough. Explaining all the possible outcomes will require more than tact.
