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An ISA (Individual Savings Account) is a savings account available to UK residents on which the return is tax-free and which need not be declared on the investor’s tax return. All income (dividends and interest) and all capital gains within the account are free of tax. For the current year, 6 April 2024 to 5 April 2025 the overall investment limit is £20,000 (excluding the British ISA which has a separate £5,000 limit).

 
Guidance

Capital Gains Tax and holdover relief

Making gifts from a portfolio heavy with capital gains.

For many investors, trying to grow their portfolio value is a primary objective. Over time, many are successful in this objective to varying degrees. Common sense tells you that objectives change as we get older. For a long time, it’s often about accumulating enough to ensure we can live out our retirement years at a desired standard. Many get to a point where they realise they have enough to meet their needs and then want to start helping others, commonly any children and grandchildren. It is at this point that another ‘problem’ arises. Capital gains tax.

Making capital gains is never seen as a problem but realising those gains often is. Typically, a person discovers that gifting away the desired mount will trigger a capital gainstax (CGT) charge. Since people generally don’t choose to pay tax voluntarily, the gift is re-thought, often leading to it being reduced drastically or not made at all. Meanwhile, in the background lurks inheritance tax (IHT), something that is likely to affect many people who find themselves in this type of scenario. The decision-making process on gifting can therefore often be strangely summed up thus:

CGT at 20% on any gains element is avoided but leaves the
entire value subject to IHT at 40%.

For a long time, it’s often about accumulating enough to ensure we can live out our retirement years at a desired standard. Many get to a point where they realise they have enough to meet their needs and then want to start helping others.

There is a potential solution that could prove useful to anyone finding themselves in the above scenario, i.e. someone who has a desire to make larger gifts now but who is reluctant to pay CGT on them. This may be even more important now given that CGT exemptions are about to reduce, coupled with the fact that the IHT tax free thresholds have been frozen again, now remaining flat until April 2028.

Typically, a person discovers that gifting away the desired amount will trigger a capital gains tax (CGT) charge.

The discretionary trust & holdover relief

As mentioned above, most gifts to another individual are classed as disposals, hence the CGT problem. However, if the gift is classified as a chargeable lifetime transfer for IHT purposes, then a claim for gift holdover relief can be made.

What does this mean in practical terms? Well, any transfer into a discretionary trust is a chargeable lifetime transfer (whereas a direct gift to an individual is a potentially exempt transfer). In other words, with the correct planning, a person could set up a discretionary trust, transfer assets into it and claim holdover relief. Doing this would result in the trustees receiving the assets at their original base cost, thereby transferring the gains to them. This far, CGT-wise, all that has been achieved is that the gains have been shifted to another person/s.

But by making the transfer into trust, the person making the transfer has now started the 7 year gifting clock. In other words, after 7 years, the capital value of the gift is outside the estate for IHT purposes. Remember also that once a gift is made, any gain in the value of the gift belongs to the person who has received it, not the donor. Thus, even though it takes 7 years for the capital value to fall out of the estate, immediate relief from IHT begins to accrue should the gifted asset increase in value. Discretionary trusts and holdover relief therefore allow a person with a CGT problem and an IHT problem to start to deal with the IHT part of the problem.

The person making the transfer has now started the 7 year gifting clock.

The longer-term CGT view

The discretionary trust solution does allow the gifting of gainsheavy assets without triggering an immediate CGT liability. But all the transfers did was hold over the gain so one of theproblems still exists, i.e. CGT may be due when the assetsare sold. The discretionary trust option may still be able toprovide some relief here.

The discretionary trust solution does allow the gifting of gains heavy assets without triggering an immediate CGT liability. But all the transfers did was hold over the gain so one of the problems still exists.

First, the trust itself will have its own CGT exemption. This is normally half of the level available to individuals, i.e. £6,150 in 2022/23, falling to £3,000 in 2023/24 and £1,500 in 2024/25. (It would be lower than this if the individual making the gift has already set up another discretionary trust). To keep matters simple, we’ll assume that is not the case here. On the surface, with the reductions to the CGT exemption that are about to happen, the availability of a much lower trust exemption doesn’t seem that attractive. On this point alone we would agree. However, once the assets have been in trust for a minimum of 3 months, the trustees could transfer ownership of assets to a beneficiary. When they do that, another claim for holdover relief can be submitted. This then moves the original gain into the hands of the beneficiary, i.e. the asset still has its original base cost. If the beneficiary, or perhaps importantly, beneficiaries, do not make use of their own annual CGT exemption, they would be able to sell these assets to do so. The end result could be a tax efficient transfer from say a parent to their adult child that achieves both CGT and IHT benefits. And even though the CGT exemption is reducing, the trustees can do this over many tax years (or they can do it in one year and the beneficiaries then do their selling over many tax years).

On the surface, with the reductions to the CGT exemption that are about to happen, the availability of a much lower trust exemption doesn’t seem that attractive. On this point alone we would agree. However, once the assets have been in trust for a minimum of 3 months, the trustees could transfer ownership of assets to a beneficiary.

The end result could be a tax efficient transfer from say a parent to their adult child that achieves both CGT and IHT benefits.

Example: John and Mary have a joint investment portfolio holding 20 positions valued at c. £700,000. This has been accumulated over many years and as a result, roughly two-thirds of the value is gains. They have been making annual sales up to their CGT exemptions and gifting the proceeds between their 3 children (and sometimes also between their 4 grandchildren – two of whom are under 18). John and Mary don’t need the capital and are now worried about IHT. In addition, they appreciate that the upcoming reductions to their CGT exemptions will limit the size of gifts they can make tax efficiently.

A local financial adviser, working in conjunction with a local solicitor, sets up discretionary trusts for both John and Mary. They transfer £250,000 of assets into each trust, leaving £200,000 in John & Mary’s portfolio. John and Mary will continue selling down assets from their portfolio annually to make continued use of their reduced CGT exemptions. They both make claims for holdover relief to apply to their respective gifts and they are both trustees of their trusts along with one of the children who is an accountant. The potential beneficiaries of each trust are their 3 children and 4 grandchildren along with a local charity.

A few months later, the trustees make a unanimous decision to transfer assets to all 8 beneficiaries. The transfer to the charity is of £3,000 capital (2/3rds being capital gain) and is tax free. Given the CGT exemption is now £6,000, the transfer to each beneficiary is £9,000 of capital, allowing immediate sales with the 2/3rds gain element of £6,000 to be sheltered by each beneficiaries own CGT exemption (if they then decide to sell). With two of the beneficiaries being under age 18, they cannot receive shares directly. Instead, a bare trust is set up with them as beneficiaries to receive their distributions, meaning their annual CGT exemptions can still be used. The trustees indicate that they will likely repeat this exercise the following tax year, albeit at a lower level given the further reductions to the CGT exemptions. However, John and Mary are happy that they now have a route to making tax efficient distributions from their trusts over time.

That sounds too good to be true

You may think that, but this is a perfectly acceptable form of planning. This link (see category 5) confirms the HMRC position. Of course, very rarely do ‘perfect’ solutions exist. If you like this idea and feel it may be worthy of further research, here are some issues to consider.

  • All trusts now have to be registered via the Trust Registration Service (TRS) This adds in some additional administration. But the registration process is not overly complex and is a one-off. Further details can be found here
  • A claim for holdover relief needs to be submitted whenever assets are transferred into or out of trust Details can be found here 
  • To claim holdover relief, beneficiaries need to be UK resident and remain so for 6 years after receiving the gift
  • It is likely that the trustees will need to submit a trust tax return. If the underlying trust assets produce income, the trustees will have to pay income tax at trust tax rates. However, it is possible that higher trust tax rates can be reclaimed by beneficiaries taxed at lower rates. This can add further administration and complexity. However, you may be able to minimise this if you are able to transfer non income producing assets into the trust
  • Discretionary trusts are subject to 10 year reviews and face a 6% tax charge on any amount of trust value that exceeds the IHT nil rate band at the 10th anniversary. If the trustees plan to make regular distributions similar to our earlier example, it is highly possible that the trust will not make it through to its 10th year. Even if it did, making distributions prior to the 10th anniversary are likely to keep the value lower and minimise the risk of any 10 year tax charge