Following record levels of government borrowing and spending to cope with the COVID-19, it is very likely that the Capital Gains Tax (CGT) legislation will be overhauled to increase the tax rates and remove many of the current tax exemptions.
Individual v couple
An individual’s CGT exposure on an asset they own with others is, in most cases, determined by reference to their share of ownership of the asset. So, say, two brothers bought a flat in Hove to rent out; one brother was not prepared to go halves on the purchase and so they own the property 2/3 and 1/3 respectively. When they rent the property out or if they sell it in the future, rental receipts and the capital gain or loss that may arise on the disposal will be split between them by reference to those proportions. For inheritance tax purposes, the same principle would apply if they own the property as ‘tenants in common’ – this means they are treated as owning their distinct shares of the property and are free to pass it to anyone under the terms of their will. If they own the property as joint tenants, each brother would be treated as owning a fractional share in the whole of the property and on death of one, the surviving owner would inherit the deceased’s share automatically.
For married couples and civil partners, the position is slightly different. Capital gains or losses will be split and taxed in accordance with the actual ownership proportions; inheritance tax will be assessed based on this ratio also (except in cases of joint tenancies – which are fairly common with spouses); but not income. The automatic assumption here is that income from jointly owned assets (be it property or other assets such as bank accounts) is shared equally between the spouses, notwithstanding the actual beneficial ownership of the asset (limited exceptions exist). This approach therefore often results in tax leakage in situations where the larger part of the asset(s) is de facto owned by a basic rate taxpayer (or even a non-tax payer) and the “minority interest” by the higher earner in the household. An example, based on 2020/21 tax rates, may illustrate the position.
Two practical examples
A married couple, Alan and Andrew, own a rental property 10:90 respectively; net rental income is £50,000 per annum. Alan works full time and is an additional rate taxpayer, whilst Andrew is a stay-at-home dad. Being treated as receiving rental income in equal shares means a tax liability of £11,250 for Alan and £2,500 for Andrew, so a total of £13,750 for the family. Splitting income by reference to actual ownership proportions means most of it is taxed in Andrew’s hands at 20%, which reduces the family’s total income tax liability to £8,750. Put simply, this is an extra £5,000 of disposable income.
To rectify the automatic 50/50 split, the couple are able to complete and file with HM Revenue & Customs (“HMRC”) a Form 17. This is essentially a notification to HMRC that the property is held in unequal shares requesting that each spouse should be assessed to tax accordingly. Once made, the declaration will be valid until permanent separation, divorce, death or a change in circumstances. There are certain requirements that need to be complied with from a procedural perspective and it takes effect from when the declaration is made – it cannot be backdated. So whilst it can address future incomings, it cannot be used to adjust the historical position.
A further planning opportunity arises where an income-generating asset is owned solely by the higher earning spouse. Consider this: Bob, an additional rate taxpayer, has an investment portfolio, which generates £15,000 worth of non-dividend income and £40,000 of capital gains. Bob’s tax liability on these amounts would be £12,350 (£6,750 in income tax and £5,600 in capital gains tax). If Bob decided to transfer even 50% of the portfolio to his wife Bhadra, who is a volunteer for a charity and has no income, with an automatic 50/50 split applying, a saving of just over £6,500 can be achieved. In a real life scenario, fine-tuning the percentages, e.g. 75:25 or 40:60, to make full use of allowances and rate bands would be necessary to mitigate the overall liabilities.
As transactions between spouses can be made on a no gain, no loss basis for capital gains tax purposes and without a charge to inheritance tax (at all or at least immediately – subject to domicile considerations), reallocating assets between them in the most tax efficient manner may seem like a no-brainer. A word of caution though: any such transfers must be genuine gifts with no strings attached, otherwise they will not be effective. So in the above example, Bhadra must genuinely be able to benefit from the cash generated by the portfolio she would part-own – as opposed to using the monies and the tax saved to finance Bob’s expenditure. As a result, practicalities and non-tax considerations of giving assets away should not be overlooked.
In addition, not all interspousal transfers will always be as beneficial as they appear – where income differences and marginal tax rates are minimal or could push one spouse into the higher tax bracket; an immediate charge can arise (for example, in relation to a solely owned property on which there is an outstanding mortgage that the transferee spouse assumes liability for); or due to transaction costs (e.g. professional fees). Careful planning is therefore required to ensure such actual and potential costs do not outweigh the shorter or the longer term tax savings. All in all, ultimately, the right answer to whether joint asset ownership is the way forward is “it depends”.
SRC-Time are one of the South East’s leading accountancy firms in advising the self-employed and partnerships in all aspects of their tax affairs and we are able to assist in any issue raised above.
Our expert team is available to provide you with advice and can be contacted on 01273 326 556 or you can drop us an email at email@example.com or speak with an account manager to get any process started.