Tax Basics

In my recent article on bed and breakfasting, you may have spotted that transfers between spouses and civil partners do not give rise to a charge to capital gains tax (CGT). However, this is due to specific rules relating to spouses, and different rules apply when transferring shares to other relatives.

Spouses -- nil gain/nil loss

The legislation permitting CGT free transfers between spouses provides that the transfer should be deemed to have been made at a value that produces neither a gain nor a loss.

Back in the good old days of indexation, this meant the 'sale proceeds' would be the equivalent of cost (or March 1982 value if relevant) plus any indexation accrued to date. As a result, the new spouse shareholder effectively received the shares with the benefit of the same deemed holding period.

Now there is no indexation available, so the 'sale proceeds' will likely equal cost (or March 1982 value if the shares have been held so long). It is important to note that for entrepreneurs' relief (if appropriate) the original spouse's holding period is not taken into account when assessing whether the one year holding period criterion has been met, so beware.

Other relatives

The treatment of transfers between spouses is specific to spouses and civil partners; no similar concession exists for other family members, not even children.

However, most generous Fools will probably give their nearest and dearest shares, rather than selling to them, so the sale proceeds of the transaction will be £nil. Right?

Er, no. As giving shares away willy nilly would be used either by those batty as a fruitcake elderly aunts we all wished we had, or by those seeking to scurrilously obtain a tax advantage, transactions between certain 'connected persons' are deemed to take place at current market value, regardless of the actual consideration (if any) that changes hands. 

This is because it comprises a transaction "not at arm's length", i.e. you would not consider giving your valuable shares away to a random individual (and if you would, please let me know)

So who counts as a connected person? An individual is connected to:

• their spouse or civil partner
• their 'relatives', which includes brothers, sisters, ancestors or lineal descendants
• the spouse or civil partner of a relative
• a relative of their spouse or civil partner
• the spouse or civil partner of a relative of their spouse or civil partner.

Although scarily wide ranging, note that the term 'relative' does not cover all family relationships; in particular, it does not include nephews, nieces, uncles and aunts. An individual will also be connected to certain companies, trusts and business partners.

HMRC have produced a handy diagram which illustrates who is 'connected' to a given individual at CG14583.

Note (Stockholm: NOTE.ST - news) also that, despite not being a connected person, our fruitcake aunt may still find herself with a CGT problem under the blanket rule of "not at arm's length". The difference is that, with connected persons, the transaction must (normally) take place at market value, and with non-connected persons, it may need to be at market value, depending on the nature of the transaction.

What is market value?

To paraphrase a children's riddle, in certain situations market value is twice as much as half its worth, particularly where unquoted shares are concerned. Valuation is easier where quoted shares are concerned, but again, shares quoted on AIM or PLUS are normally valued as if they were unquoted, given the often infrequent nature of transactions on these markets.

Anything else?

Although any decision to bestow shares upon a loved one may have come from altruistic intentions, there are a number of other things to consider. Sorry.

It may be possible to effectively defer and transfer any CGT liability arising to the person actually receiving the value by using a gift relief. Here, both parties to the transaction jointly elect so that any gain arising on the original disposal is deferred until the subsequent disposal by the new owner. Unfortunately this type of relief only applies to business assets (such as unquoted shares) or certain gifts into trust.

Secondly, and again particularly with unquoted shares, it is possible that a transfer to a relative, if a mutually agreed sum has been paid, could give rise to a loss. This is because the valuation by HMRC will discount minority holdings to obtain an open market value, which may not be reflected in family company transactions. Any such loss created, unsurprisingly, may only be used against gains on sales to that same connected person while still connected.

Finally, and most importantly, if anyone is transferring anything at anything other than an actual market value, you need to think of any inheritance tax (IHT) implications. Gifts to individuals are normally potentially exempt transfers, meaning they are not immediately chargeable to IHT, but death of the transferor within seven years could result in an unexpected charge.