Taxation of gifts under UK law is complicated and rather counterintuitive. It throws many surprises at the parties participating in a gift arrangement, particularly, since it’s the person making a gift as opposed to the one receiving it, who may be liable for tax. This article aims to shed light on the most common situations arising from making gifts between family members and third parties.
Tax liability in connection with a gift transaction revolves primarily around tax residence and domicile of the persons making and receiving the gift. Readers are reminded that UK tax residence is determined on the basis of the Statutory Residence Test (SRT). The test considers the number of days (midnights) a person spends in the UK during a tax year (6 April-5 April) together with a number of specific factors. These include having a home in the UK, family, work in the UK, as well as the length of time that the person spends in the UK in the previous tax years. Contrary to the popular belief, one can become UK resident even if they spend less than six months in the UK. HMRC have helpfully summarized the SRT in the brochure RDR3 (https://bit.ly/1NwfHop).
Domicile is what determines how closely a person is connected with a particular country. It is a private law concept which under UK law determines availability of certain tax reliefs such as the remittance basis of taxation. People are born with domiciles of origin which can later be replaced by domiciles of dependence or choice. British citizenship is not necessarily an indicator of the domicile. Although, more often than not “British” people born in the UK of “British” parents have UK domicile. Additionally, a person who has spent substantially long periods of time in the UK may acquire deemed domicile which from the tax point of view for mostintentsand purposes is equivalent to the more traditional domicile. To learn more about the concept, readers are invited to consult HRMC’s Chapter 5 of brochure RDR1 (https://bit.ly/1OSQCcw).
Moving from the simple to the complex, it is better to begin considering the UK tax liability of the gift recipients who in most circumstances are not liable to any tax whatsoever. The absence of tax liability does not depend on whether the gift is received from a relative, an unrelated person or from a corporation.
However, at the same time, this is only true provided that the gift is a bona fidegratuitous transfer of the object formerly belonging to the donor. Conversely (and logically), a donee who structured receiving their own income through the gift arrangement with the donor’s help will be liable to tax on the received amount under the usual tax rules. To illustrate these ideas, say a UK tax resident who is receiving an apartment located in or outside the UK from their parents or an unrelated well-wisher, is not liable to tax nor is he liable to report the gift in his UK tax return. At the same time, say if the same person owns a foreign trading company whose shares he transfers to someone who is resident outside the UK, who then uses the dividends from the company to make regular cash gifts to the former, he is likely to have to declare the gifts to HMRC.
Receiving a gift from a corporation is less frequent but not impossible. In the author’s experience, typically a non-UK resident parent with an offshore company would order it to pay for property to be acquired by his children, resident in the UK. The company could also finance the acquisition of other goods and services. It would be less rare for the company’s shareholder to receive distributions from the company in the form of a gift. Provided that the child in this example is neither a director (real or shadow) nor company’s shareholder, the receipt of the funds will not be considered income liable to tax or reporting. Conversely, if the donee in any way controls the company or provides any services for its benefit, the funds will be considered as a taxable distribution interpreted either as dividends, salary or director’s fees.
As mentioned on a few occasions, because bone fidegifts are not considered income or chargeable gains, they are not liable to be reported in the person’s annual self-assessment report. However, a significant gift in the absence of declared income or gains may cause HMRC to inquire into its origin. Therefore, there is an argument in favour of notifying them of the donation in the “white space” in the person’s tax return. Also, significant gifts should be evidenced by deeds of gift. These might be requested by solicitors or banks that might inquire into the source of funds.
The scope of the donor’s tax liability is significantly broader. Beside his residence and domicile, one should consider the object of the gift and its location. Taxes that may arise when making the gift are capital gains tax and inheritance tax. It is impossible to cover all different permutations and the following examples cover the most frequently arising situations.
Most commonly, parents gift money to their children. Practically speaking, in most circumstances, non-UK resident parents can gift money to their UK-resident children without any UK tax consequences, provided that the transfer is made between bank accounts opened outside the UK. One notable exemption is where the parents are domiciled or deemed domiciled in the UK in which case the gift might be considered a potentially exempt transfer (PET).
The effect of the gift being considered a PET is that if the person making the gift dies within 7 years, its amount (or its market value in case of a non-monetary gift) will be included in their estate and, possibly, liable to 40% inheritance tax. If the parents in the above example transfer the funds from a UK bank account, it will be considered a gift of the UK situated assets which will be treated as a PET with the above consequences. Usually when the funds are kept in the UK, the easiest way to avoid the effect of the PET is to transfer them to the non-UK parents’ bank account prior to gifting them to their children, thus turning the subject of the gift to a non-UK asset.
When gifting non-cash assets, it is necessary to consider CGT consequences. From the donor’s point of view, a gift is a disposal which may be treated in the same way as a sale. When the gift is between connected persons (for example, family members), the disposal is considered to be effected at the assets’ current market value. Put simply, the difference between the current market value on the disposal and the cost of the acquisition forms what may be liable to tax. Normally, non-UK residents only incur liability when gifting residential real estate located in the UK (also non-residential real estate starting from April 2019) and are not liable to tax when gifting other assets. At the same time, UK residents making gifts are liable to UK CGT regardless of the location of the gift. However, if the donor is not domiciled in the UK and the assets are located outside the UK, they may claim the remittance basis of taxation in which case it is possible to avoid liability when making such a gift. Of course, tax may arise if the recipient later brings the gift to the UK which might constitute a remittance. However, a detailed discussion of these rules falls outside the scope of this article.
It is also necessary to consider IHT consequences when gifting property other than cash. A gift of UK real estate will always constitute a PET since naturally it cannot be moved outside the country prior to making the gift. The same applies to other UK situated assets such as shares in UK companies. Unless specific planning steps are taken in advance, for example taking out inheritance tax insurance, IHT liability may arise to donors who are resident in and outside the UK. Conversely, foreign real estate as well as other non-UK situated assets, for example shares of a non-UK registered company or family diamonds which were removed from the country before the transfer, most likely will not trigger any IHT consequences if their non-domiciled donor dies.
There are a number of exemptions that minimize IHT liability. For example, gifts between spouses are not considered a PET (but transfers between spouses one of whom is not domiciled in the UK may be) as well as taper relief which reduces the amount of IHT in proportion to the time that passes between the gift and death. At the same time, it is necessary to consider various anti-avoidance rules. These include gifts with reservation of benefit (GROB), which apply in a situation where the transferor continues to benefit from the gift after having transferred it to the transferee, for example, continuing living in the gifted apartment. In this situation, unless the donor moves out of the property or starts paying market rate to the recipient, the 7-year term will not start running.
Liability to UK taxes when making gifts which depends on UK residence and domicile statuses as well as on whether the person is taxed on the remittance or arising basis can be summarised as a table:
|UK res/dom||UK res/non-dom/arising||UK res/non-dom/remittance||Non-UK res|
|Real estate in the UK||CGT, IHT||CGT, IHT||CGT, IHT||CGT, IHT|
|Real estate outside the UK||CGT, IHT||CGT||–||–|
|Other property in the UK||CGT, IHT||CGT, IHT||CGT, IHT||IHT|
|Other property outside the UK||CGT, IHT||CGT||–||–|
|Money in UK bank accounts||IHT||IHT||IHT||IHT|
|Money in non-UK bank accounts||IHT||–||–||–|
In conclusion, let’s consider a few additional examples.
Non-UK resident parents who are resident and domiciled outside the UK normally can gift to their UK resident child without any UK tax consequences. However, if they gift property situated in the UK, they should consider possible non-resident CGT liability as well as IHT liability if they die within 7 years from making the gift or if they continue using the property. Although not covered in this article, other possible taxes may include stamp duty land tax (SDLT), if there is mortgage secured over the property, and pre-owned asset tax (POAT) if the parents become UK resident in the future and start using the apartment.
A UK-resident non-UK domiciled child will normally incur no IHT consequences when gifting his non-UK resident parents his foreign real estate. However, if during the ownership period the cost of the property has appreciated (in £) he may face CGT liability, which can normally be avoided only subject to claiming the remittance basis of tax. Also, if in the near future the parents sell the property that they had received and gift the proceeds to the child from their non UK bank account they will avoid UK liability; however, the recipient of the funds may incur CGT liability as the original gain would be considered remitted to the UK unless he proves that the gift is a bona fidegratuitous transaction.
The above article is reprinted with the publisher’s, Wolters Kluwer, permission from Global Tax Weekly, and will appear in issue no.312 dated 1st November 2018.
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I look forward to seeing you there.
With warm regards.
ADIT(Affiliate) LL.M(Tax) LL.B(Hons)
Partner, IFS Consultants, London