Capital Taxes and Trusts

Capital gains tax (CGT) annual exemption

The annual exemption for 2004/05 is £8,200. For most trusts the exempt limit is increased to £4,100.

CGT rates of tax - individuals

Capital gains continue to be treated as the top slice of income. For 2004/05, rates continue to be aligned with those applying to savings income. Tapered gains are charged at 10% where gains plus total income do not exceed £2,020; 20% between £2,021 and £31,400; and 40% on any balance.

CGT rates of tax - trustees

From 6 April 2004 the rate of CGT for trustees will be increased from 34% to 40%.

Gift relief

Where a capital asset, say shares or property, is the subject of a gift then for CGT purposes it is generally treated as a disposal of the asset at its market value so that either a gain or loss arises. However where a gain arises it is possible, so long as certain conditions are satisfied, to defer the gain using the gift relief provisions. The gain is then charged to tax on any subsequent disposal by the recipient.

The conditions to be satisfied are broadly either that the asset in question is a ‘business asset’ or that the gift is of the type that is immediately chargeable to inheritance tax (generally gifts to discretionary trusts).

The government is concerned that certain avoidance schemes have been used, the effect of which is to defer a gain under the gift relief provisions but in such a way that the deferred gain is ultimately eliminated or reduced.

Provisions were therefore announced in the Pre-Budget Report on 10 December 2003 to deny gift relief in certain circumstances. Two main scenarios are envisaged.

The first involves the gift of an asset to a trust in which the donor has some sort of interest (a ‘settlor interested trust’). With effect from 10 December 2003, gift relief is denied altogether on such transfers. The effect is to crystallise the gain on the transfer.

Comment

Since CGT taper relief was introduced in 1998, settlor interested trusts have often been used to improve the taper relief position on the ultimate disposal of assets. Although this does not seem to be the mischief at which the December 2003 announcement is aimed such transactions appear to be caught.

The second is aimed at a more specific scheme where a discretionary trust is used to defer a gain on a property that is then occupied by one of the beneficiaries as their main residence. On disposal of the property by the trustees the whole gain is exempt from CGT under the main residence exemption rules. The government has moved to block this device so that either the gain on set up of the trust can be deferred or main residence relief can subsequently be claimed but not both. This measure also took effect on 10 December 2003 and may also affect the main residence relief available where the property was transferred into the trust before that date.

Reporting requirements for capital gains

As announced in the 2003 Budget, for tax returns from 2003/04 onwards, there will be fewer situations where the capital gains pages of the return need to be filled in. The pages will not need to be completed where the total gains after taper relief do not exceed the annual exemption unless either:

the proceeds exceed four times that amount or
there are allowable capital losses in the year.

Taper relief: definition of business asset

As announced in the 2003 Budget, the definition of a business asset for taper relief purposes has been further relaxed and the changes take effect on 6 April 2004. Currently, the rules determining whether assets other than shares or securities qualify as business assets for taper relief purposes generally require that the owner of the asset uses it for trading purposes. The exception is where an investment property is let to an unquoted trading company. The proposed changes will mean that assets used for trading purposes will qualify as business assets irrespective of whether the owner is involved in carrying on the trade concerned.

Comment

These changes remove the current anomaly whereby an investment property let to an unquoted trading company constitutes a business asset but if let to a partnership (in which the owner is not a partner) it does not.

Inheritance tax (IHT) threshold

The IHT nil rate band is increased in line with inflation to £263,000 with effect from 6 April 2004.

Administration of IHT

Measures will be introduced later in the year to bring more estates within the simpler reporting regime for IHT. Other than in the largest estates, an IHT account will be required only where there is tax to pay.

In addition the IHT penalty rules will be brought more closely in line with those for income tax and CGT.

Trusts

As previously announced and referred to elsewhere in this summary, the rate of tax on the income and capital gains of trusts will increase from 34% to 40% with effect from 6 April 2004.

A further package of measures is under consideration to modernise the tax system for trusts and the likely start date is April 2005. The main proposals are as follows:

to introduce a basic rate band of £500 for trusts so that around 30,000 trusts with small amounts of taxed income will have no further liability and will no longer have to submit a self assessment return every year
to bring in new rules so that trusts set up for the most vulnerable, for example, for the disabled, are taxed as if the beneficiary had received the income and gains directly.

Further detail is expected in the 2004 Pre-Budget Report.