Article by Keith M Gordon, a director of ukTAXhelp Ltd.
This article appeared in the February 2003 issue of Tax Adviser: part one appeared in the January 2003 issue.
Rules that govern the transfer of assets between spouses have become unnecessarily complex since the introduction of taper relief. The complexity is worsened by the fact that the new rules seem to have no justification and contain anomalies.
The rule before taper relief
Until taper relief was introduced inter-spouse transfers were governed by a simple rule that ensured that such transfers were on a nil-gain-nil-loss basis. This rule is in Taxation of Chargeable Gains Act 1992 (TCGA 1992), s. 58(1).
While this meant that individuals did not need to account for capital gains tax (CGT) if they transferred assets to their spouses, it had the added advantage that for calculation purposes, the transferee spouse (i.e. the spouse who received the asset) simply stood in the shoes of the transferor or ‘transferring’ spouse. See Example 1.
Suppose Mr A bought a painting in January 1990 and gave it to his wife in 1995. If his wife sold the painting in 1997 she could simply pretend she had bought it in January 1990.
To be precise it would have been necessary to calculate indexation allowance in two goes – first up to the date of the inter-spouse transfer and secondly for the period after that date. However, the difference is negligible.
The rules under taper relief
For inter-spouse transfers after 5 April 1998, the nil-gain-nil-loss basis still applies. As a result, there is still no need for spouses to account for CGT if they transfer assets between each other.
However, when the transferee spouse disposes of the asset the taper relief rules need to deal with the two factors that determine how much taper relief is available:
Length of ownership – basic rule
- the length of time that the asset has been owned; and
- whether the asset qualifies as a business asset during this combined period of ownership.
As one would expect, the transferee spouse acquires the transferring spouse’s period of ownership. This was implicit under the old rules, but now needs to be made explicit. This rule is found in TCGA 1992, Sch. A1, para. 15(2). See Example 2.
Suppose Mrs B buys an investment property in June 1998, transfers it to her husband in January 2000 and the husband sells it in December 2002.
The husband is treated as having owned the property since June 1998 and therefore qualifies for four and a half years’ worth of taper relief.
There will also be cases when there is a chain of inter-spouse transfers. The legislation provides that the spouse who makes the final disposal can look to the beginning of the chain when calculating the total length of ownership. See Example 3.
Suppose Mr C acquired an asset in September 1998 which he sells to his wife in February 1999 and she then gives the asset back to her husband in April 2000.
If Mr C sells the asset to a third party in November 2002 he is still treated as having acquired the asset in September 1998 – the date the asset first came to the couple.
Periods before 6 April 1998
These rules cannot be used to extend the length of ownership to include any period before 6 April 1998 because this period is always ignored for taper relief purposes. However, if the transferring spouse owned the asset on 17 March 1998 (the day the rules were announced following the Budget speech) and the asset qualifies for the bonus year, then the transferee is entitled to take this into account. See example 4.
If we look again at Mr and Mrs B in Example 2 and suppose now that Mrs B had acquired the property in June 1997 and transferred it to her husband in January 2000.
When Mr B sells it in December 2002 he will be treated as having acquired the property in June 1997 (the date his wife acquired it). However, he will only be able to count the part of that period that falls after 5 April 1998 – in this case just over four and a half years – plus the bonus year where appropriate.
Is the asset is a business asset?
Having established the period of ownership of an asset, it is now necessary to determine whether or not the asset was a business asset during this period.
It would have made a lot more sense if one could simply look at the use to which the asset was being put during the combined period of ownership and calculate the taper relief accordingly. Additonally, it appears that this was the original intention of the legislation since the notes that accompanied the Finance Bill in 1998 said that this was the its purpose.
Unfortunately, the legislation does not actually provide for this – in some instances the legislation provides for more generous relief and in others the rules are less generous.
What does the legislation say?
The legislation is found in TCGA 1992, Sch. A1, para. 15(4). It modifies the legislation earlier in that schedule. The problem is that the modified legislation only relates to assets other than shares.
In other words, there are two distinct sets of rules – one dealing with shares and one dealing with other assets.
The rules for shares
Since there is no provision that deals with inter-spouse transfers in the case of shares, one has to turn to the normal rules to determine whether shares represent business assets or not. These are in para. 4 of Schedule A1 – as supplemented by para. 6 and 6A which look at the meaning of ‘qualifying company’.
However, it is para. 4 that is important here and, in particular, para.4(2) that states:
‘Where the disposal is made by an individual, the asset was a business asset at that time if at that time the relevant company was a qualifying company by reference to that individual.’
In other words during the combined period of ownership, one has to look at whether or not the company was a qualifying company by reference to the spouse who eventually sells the shares – even if that spouse did not own any of the shares at that particular point in time.
Until 5 April 2000, it was impossible for a company to be a qualifying company by reference to a non-shareholder. However, this is now possible in respect of unlisted trading companies.
The effect of this rule can be best explained by use of examples. See Examples 5 and 6.
Suppose Mr D works for a quoted company. In July 2000 he bought a one per cent shareholding which he to gave his wife one year later. Mrs D then sells the shares in January 2003. For simplicity, assume that Mr and Mrs D do not own any other shares in the company.
Mrs D will only be entitled to treat these shares as business assets if Mrs D was also an employee of the company.
The fact that Mr D was a shareholding employee for a year makes no difference.
Following on from Example 5, suppose now that Mrs D were to return the shares to her husband who then sold them.
As it is Mr D who makes the final disposal we need only look at whether the company is a qualifying company by reference to him.
Since he was an employee, the company is a qualifying company and therefore the shares qualify as business assets throughout the combined period of ownership – even though Mr A did not actually own the shares for some of this period.
The rules for shares if they were owned before 6 April 2000
More care is needed if the shares were owned before 6 April 2000. This is because the previous definition of a qualifying company required a minimum shareholding of five per cent for full-time employees and 25 per cent for others. See Example 7.
Suppose Mrs E owned ten per cent of the shares in her employing company and she then gave them to her unemployed husband in May 1999, the shares would not be treated as business assets between May 1999 and April 2000 irrespective of which spouse eventually disposes of them.
Had Mrs E retained a five per cent shareholding, then the shares would qualify as business assets throughout – provided she makes the final disposal.
The rules for other assets
For other assets the rules are more generous, but no less anomalous. That is provided for in TCGA 1992,Sch. A1, para. 15(4) which states:
‘Where there is a disposal by the transferee spouse, any question whether the asset was a business asset at a time before that disposal shall be determined as if –
(a) in relation to times when the asset was held by the transferring spouse, references in paragraph 5(2) above to the individual by whom the disposal is made included references to the transferring spouse;’
Paragraph 5(2) deals with different situations – for example paragraph 5(2)(a) states:
‘Where the disposal is made by an individual, the asset was a business asset at that time if at that time it was being used, wholly or partly, for the purposes of a trade carried on at that time by that individual or by a partnership of which that individual was at that time a member.’
It is therefore necessary to divide the combined period of ownership into two sub-periods:
- the period up to the date of the inter-spouse transfer (or, in accordance with a common sense interpretation of paragraph 15(5), the last such transfer); and
- the period after this date.
For the period up to the date of the inter-spouse transfer, references in para. 5(2) to the person making the disposal are to be read as ‘including the transferring spouse’. Thus one can consider whether the asset qualifies as a business asset in respect of either spouse.
For the period after the inter-spouse transfer, one should only consider whether the asset qualifies as a business asset in respect of the spouse who makes that final disposal (i.e. applying the plain meaning of para. 5(2)). See Examples 8 and 9.
Suppose Mr F runs a manufacturing business. He owns the freehold of the factory site. This freehold is therefore a business asset as far as he is concerned.
If he gave the factory to his wife, however, no business asset taper relief would be available in respect of the period after this transfer if his wife later sold the site.
Assuming the facts of Example 8, but now suppose that Mrs F gave the factory back to Mr F before it is sold to a third party.
Then the factory would be treated as a business asset in respect of the combined period of ownership:
- for the period up to this last transfer – because the factory qualifies as a business asset in respect of at least one of the spouses and
- for the period after this transfer – because the factory qualifies as a business asset in respect of Mr F.
The rules for other assets
To conclude, the rules are not straightforward and can easily lead to unexpected tax liabilities. However, if care is taken it can be possible to take timely action and maximise spouses’ entitlement to taper relief.
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January 2003 by