IHTM42163 - Relevant property: Capital Gains Tax and Income Tax deductions
1. Capital Gains Tax (CGT) and holdover relief
Any CGT incurred and payable prior to the ten-yearly anniversary (TYA) is deductible from the TYA value in the normal way.
This evidence of actual payment is important in CGT cases, because there will often be occasions where the CGT liability has been quantified and agreed, but the taxpayer elects for holdover relief under TCGA92/S165 or S260. In such a case the CGT is not in fact paid and deduction against the inheritance tax value is not due.
2. Potential CGT
A claim is sometimes made at the TYA that the trustees can never obtain the full open market value of the settled fund because, in realising the assets, CGT will certainly be payable. It is argued that the value of the fund should be discounted to reflect a potential tax liability. No discount is allowable as the claim to tax arises on the property comprised in the settlement and this does not include potential tax liabilities.
3. CGT on dispositions from the trust
This depends on who pays the tax. You can allow a deduction only where the value in the hands of the recipient will be reduced because of the CGT payable by that recipient.
IHTA84/S165 (2) specifically covers the case where a chargeable transfer (incurring a proportionate charge for inheritance tax) includes a disposal for CGT.
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Deduction of the CGT is not allowed on the lifetime transfers basis provided by IHTA84/S165 (1), but if the trustees of a discretionary settlement incur a liability for CGT on the proportionate charge and it is borne by a person who becomes absolutely entitled to the settled property concerned, the amount of the CGT paid is deductible.
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If the trustees bear the CGT out of remaining settled funds the CGT payable is not deductible against the taxable property.
Where the whole fund is the subject of the transfer/proportionate charge then it will not be possible for the trustees to pay CGT from retained funds, and the property in the hands of the recipient will inevitably be reduced by the CGT, so you can accept the deduction.
Transfers to other settlements
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The person becoming absolutely entitled need not take beneficially – the transfer could be to the trustees of another settlement – see Hoare Trustees v Gardner [1978] 1 AER 791.
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In the case of a transfer to another settlement IHTA84/S81 may well apply, but provided that the transfer is a chargeable transfer for Inheritance Tax (IHT) purposes the CGT deduction is not affected by S81, which is purely an IHT provision.
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Where the transfer is from one discretionary settlement to another discretionary settlement there is no chargeable transfer against which a deduction can be taken.
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These rules apply equally to interests in possession.
4. Income Tax deductions
The rule of general law is that income debts should be paid out of income. But it is more fitted to interest in possession trusts, where the decided cases seek to hold a balance between life tenants and those entitled in remainder – Carver v Duncan [1985] STC 356. The settlor may authorise the payment of capital debts out of income, or income debts out of capital, but cannot change the nature of the source used.
The value of the rule is debatable in trusts where there is no income on hand from which the income tax can be paid. Where a worthwhile amount of IHT is at stake you should consider the deduction, taking the following points into account:
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It may be that some income has been included among the relevant property (the deduction would be right, but the inclusion wrong)
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It may be that there is income on hand which the taxpayer has quite properly left out of the of account.
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If there is no income available, ask the taxpayer for details of the income that arose and what became of it. The facts can then be considered.