Surprising loved ones with a gift can potentially backfire on the donor, who may end up with a tax charge in exchange for giving up the asset. Depending on the recipient, the nature of the asset and its value, a gift could lead to a capital gains tax (CGT) or inheritance tax (IHT) charge.
What is A ‘Gift’?
Apart from outright gifts, a sale to a connected party at less than the asset’s market value is also considered a gift from the tax perspective. In either case, the market value of the asset at the time of the transfer is treated as the proceeds of the transaction. This is different from the normal CGT treatment of an asset being sold at a reduced price to make a quick sale.
Connected Party
Excluding a spouse or civil partner (to whom any transfer is free from a CGT or IHT charge), a connected party for a donor can be any of the following:
- direct ancestors;
- direct descendants;
- siblings;
- spouse or civil partners of any of the above; and
- connections of spouse or civil partner.
Warning: Clogged Losses!
A loss arising from a transfer of an asset to a connected party can only be adjusted against any gain arising from a transfer to the same person.
CGT Relief and Exemptions
Although it may seem unfair that a gift could give rise to a gain, if planned effectively, the donor may get away with paying reduced or no CGT by utilising the annual exemption (£6,000 for 2023/24). The donor may also be able to gift the gain to the recipient without a CGT charge if:
- the transfer was of a business asset; and
- both parties agreed to claiming gift relief on it.
The gain becomes taxable when the recipient sells the asset to a third party, effectively transferring
the liability from the original donor to the recipient. The gift of a residential property owned and used by the donor may be completely exempt because of private residence relief.
IHT Implications
Unlike CGT, cash gifts are relevant for IHT purposes. An asset gifted to another individual in the lifetime of the donor is treated as a potentially exempt transfer (PET). This means that no tax is payable at the time of the transfer and the asset has the potential to become completely exempt from IHT if the donor survives at least seven years after the transfer. An IHT charge can arise where assets are transferred in the event of the death of the individual within the seven-year PET period. As the value of the asset is expected to increase over time, transferring assets during the donor’s lifetime is encouraged. This is because if they do become taxable in the event of the donor dying within seven years, the value on which the tax charge applies will be lower than if the asset is part of the death estate.
IHT Reliefs and Exemptions
The value of lifetime transfers can be reduced by the annual exemption amount (£3,000 for 2023/24), and the tax charge on transfers on death may be reduced if taper relief is available. If the value of the transfer is below £325,000 (i.e., the limit of the nil-rate band available to each UK-domiciled individual), the transfer could be completely free from IHT. Gifts on the recipient’s marriage, depending upon the family relationship to the donor, can be exempt up to a maximum in some cases of £5,000. Regular Christmas gifts, birthday presents, etc., are also exempt, provided the donor can maintain their usual standard of living after the transfer.
Practical Tip
Keep the value of the total gifts to an individual in a tax year below £250 if possible, as this will be exempt from IHT.
