Malcolm Finney takes us through the problem areas of inter-spouse transfers and why marriage, per se, may not be sufficient for tax exemption.
Basic exemptions
No capital gains tax or inheritance tax liabilities arise on inter-spouse transfers. This enables tax planning to be carried out to mitigate either tax.
Thus, for example, if a husband wishes to sell his shareholding in XYZ Ltd but has utilised his exempt annual exempt amount (i.e. £11,100 for the tax year 2015/16) he is able to simply transfer the shares to his wife to sell who can then make use of her otherwise possibly wasted annual exempt amount. In addition, no inheritance tax liability arises on the transfer.
Estate equalisation for inheritance tax
If the husband and wife’s estates are very unequal, in order to offer flexibility and mitigate inheritance tax on both deaths it may be appropriate to equalise their estates by effecting inter-spouse transfers precipitating neither capital gains tax nor inheritance tax charges.
Exemptions conditional on satisfaction of conditions
Conditions must be satisfied if exemptions from such tax charges on inter-spouse transfers are to apply; otherwise it is likely that both capital gains tax and inheritance tax charges will arise.
The conditions are not identical with respect to both taxes.
Exemption from capital gains tax requires that the spouses are living together. Exemption from inheritance tax has no such requirement; marriage, per se, is sufficient. Thus, if the spouses are separated but not divorced, inter-spouse transfers between them continue to benefit from the inheritance tax exemption. However, such transfers will precipitate capital gains tax charges as the inter-spouse exemption will no longer apply for capital gains tax purposes (following the tax year of separation).
‘Living together’: what it means
Living together (basically means what it says) but if, for example, a wife resides in the UK whilst the husband resides and works abroad the capital gains tax exemption still applies (assuming the couple are not separated i.e. no longer functioning together as a married couple).
Different domiciles: inheritance tax issues
Domicile very broadly refers to where an individual resides and intends to reside permanently/indefinitely.
For capital gains tax purposes, inter-spouse transfers are exempt, irrespective of the domicile status of each spouse. This, however, is not so for inheritance tax purposes.
Where a UK domiciled spouse effects transfers to a non-UK domiciled spouse (but not vice versa) there is a limit above which such transfers fall liable to inheritance tax. Assuming that no lifetime transfers have been made by the UK domiciled spouse, on death, if everything is left to the surviving non-UK domiciled spouse the first £325,000 is exempt; the next £325,000 (albeit at 0%) with any excess is taxed at 40%.
Example: inter-spouse transfers and inheritance tax charges
Herbert Smith, a UK domiciled individual, married Sophia Moren, an Italian domiciled individual.
Mr Smith dies leaving his estate of £700,000 to Sophia.
£325,000 is exempt; the next £325,000 taxed 0%; and the balancing £50,000 taxed at 40% giving an inheritance tax charge of £20,000.
If, on the other hand, Sophia died leaving all her estate of £700,000 to Herbert no inheritance tax charge arises.
Matrimonial home: joint tenant inheritance tax danger
If spouses have different domiciles and own their home as joint tenants, on the death of one spouse their interest automatically passes to the other spouse. If the first death is that of the UK domiciled spouse then their interest automatically passes to the non-UK domiciled spouse, which may cause an inheritance tax charge to arise, depending upon the figures involved.
Practical Tip:
Before making any inter-spouse transfers ensure that the conditions for both capital gains tax and inheritance tax are satisfied if nasty tax charges are to be avoided.
