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IHT - Related Property, Diminution in value

Husband and wife have a joint shareholding, W gifts such that control is lost does this affect H?

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Hello Aweb, long time lurker but first time poster!

If I have the position whereby H & W own a company 50/50  and W would like to settle 26 shares into trust, resulting in the joint 74% holding being worth much less over all due to the inability to block a special resolution. Would the diminution in value to H's estate be exposed to IHT (on the basis that 50/74 would be worth less than 50/100) due to the related property rules?

I have read Ray and McLaughlin's Practical IHT planning which seems to conclude that H's diminution would have no exposure to IHT, albeit I am struggling to satisfy myself that this is the case. Can anyway offer some guidance on this? Perhaps I am missing something relatively straightforward here, as I confess my previous exeperiences with IHT have been cursory rather than in the detail.

Thanks

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By AB_85
02nd Jul 2022 23:00

Husband hasn’t made a transfer of value so I don’t see how the related property rules in s161 come into play. There isn’t any transfer to put a valuation on as regards the husband’s shareholding.

There may be a wide range of IHT and CGT consequences for the wife regarding the proposed settlement into trust but further information would be needed.

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Replying to AB_85:
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By Taxguy96
03rd Jul 2022 12:52

Thank you; just to aide in my understanding say Husband gifted a single share I imagine this would change the position such that the related property rules would kick in?

In my theoretical example, I’m happy that we can hold any gain over via a s.260 election and that the shares qualify entirely for BPR.

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Replying to Taxguy96:
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By AB_85
03rd Jul 2022 17:07

If the trust were settled jointly by H&W? Yes in that case my understanding is the related party rules come into play. Presumably you then have a chargeable transfer valued on the basis of going from 100/100 to 74/100, with the transfer allocated pro rata between H&W depending on the number of shares settled by each party.

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By Taxguy96
03rd Jul 2022 18:56

Thank you very much for your help.

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Replying to Taxguy96:
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By Tax Dragon
04th Jul 2022 05:44

I thought I agreed the first response... actually I still agree the first response, H has not made a ToV so is not taxed on anything. Of course W's ToV is determined in accordance with the related property rules.

The first respondent's second response has confused me though. There is no concept of a joint ToV in IHT law, afaik.

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Replying to Tax Dragon:
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By Taxguy96
04th Jul 2022 08:17

In relation to the second response, I took that to mean at or around the same time as W’s settlement.

In that if it happened (H settling a single share) at the same time as, or was contemplated to be at the same time as W’s settlement then the diminution in H’s estate would be far larger than if he settled a single share way down the line; given the related property would already be less than a 75% holding, and, as you learned folk have taught me, no ToV for H upon W’s sole settlement first.

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By Tax Dragon
04th Jul 2022 09:19

Yes I think I read it too fast.

Or too early in the day.

'Joint' would mean 'simultaneous'; the reverse is not true.

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By Tax Dragon
04th Jul 2022 05:48

Who are the trustees? Is she really giving up control?

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By Taxguy96
04th Jul 2022 08:11

I would imagine both H&W would be trustees.

But is her role as a trustee not seen as separate from that of the settlor? If there is an argument to the contrary I would be delighted to hear it.

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Replying to Taxguy96:
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By Tax Dragon
04th Jul 2022 08:30

It was a valuation question, not a tax one.

I am not qualified to reply to valuation questions, but I don't see why I can't ask them.

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By Taxguy96
04th Jul 2022 08:56

In that case I will respond, I would see that her role as a trustee is completely separate from that as the settlor and whilst in reality she would retain control, for fiscal valuation purposes as a settlor she has lost control thereby the diminution is higher than just a pro-rata reduction of the capital value.

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By Tax Dragon
04th Jul 2022 09:31

Thank you for the response.

The reason I've been given for not being qualified is that valuation is an art, not a science; a picture not a formula. Judgment may be needed as to whether in reality she would retain control, and any discounts reduced if so.

Have I been given a false reason? (Not that this is work I would want to do anyway!)

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Replying to Tax Dragon:
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By Taxguy96
04th Jul 2022 10:36

Indeed valuation is an art, but I believe judgement comes into in terms of discounts applied, multiples applied to earnings etc.

However, the legislation is clear that we value the specific holdings at what a third party purchaser acting at arms length would pay. The holdings in question are 100% and 74%, and whilst in reality control is retained by the settlor I do not believe we should consider this when looking at the diminution to settlors estate.

@AB_85, I think your anecdote agrees with my view point, so thank you.

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By AB_85
04th Jul 2022 10:01

I think I agree with this, though I also agree with TD that valuation is a specialist area and one needs to tread carefully.

At last month's STEP conference, Emma Chamberlain gave an example in a very different context which may still support the broad valuation principle at stake. A company is owned by four trusts (25% each), settled at different dates, but with the same trustees and beneficiaries - presumably in the days when pilot trusts were all the rage. Her contention was that in such a case each trust's shareholding should be valued on a minority interest basis ie separately. As I say, caution needed as the context is different, but perhaps this is relevant to the principle.

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By The Dullard
04th Jul 2022 10:01

People are confused. This is more of a maths question than an IHT question.

H and W currently own 100% (50%:50%), being 100 shares (50:50). Let's assume that, instead of W transferring 26 shares as per original (it doesn't actually matter), W transfers 24 and H transfers 2.

To get to the transfers of value, we need to find out how much the estates have dropped.

For both H and W we need to first value their combined holding before. Let's say that's £1 million (no discount as 100%).

Then for both H and W we value their combined holding after and the combined holding has fallen below 75% (a cliff edge for discounting purposes) so we value the 74% as £1 million x 74% x 80% (assuming a 20% discount* is appropriate) = £592,000.

So, the total transfer of value is £408,000. That gets apportioned between H and W 2/26 x £408,000 for H and 24/26 x £408,00 for W.

Had W transferred all 26 shares her transfer of value would have been the whole £408,000 that had left W's and H's combined estate.

As I say, the OP makes a meal out of maths. Not IHT.

NB. The discount applied is for illustration only. The actual discount (if appropriate) would probably be smaller (perhaps 10%) IRL as 75% is much less of a cliff face than 50%. Also, the application of a discount might not be appropriate to the circumstances.

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Replying to The Dullard:
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By Tax Dragon
04th Jul 2022 10:21

No, Dulls. If W gives all 26 shares: H's estate diminishes by the applicable discount factor, if any, so if 20% that's £100k (and not taxed); W's by £308k (CLT).

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Replying to Tax Dragon:
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By Taxguy96
04th Jul 2022 10:31

Indeed my original question was whether the £100k would be exposed to IHT hence why I think it is an IHT question as opposed to purely maths.

Thank you all for your input, it really has been very helpful and quite an enjoyable first time posting experience.

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Replying to Tax Dragon:
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By More unearned luck
05th Jul 2022 16:08

But H hasn't made a transfer of value. How does it matter that he is worth less than he was?

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Replying to More unearned luck:
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By Tax Dragon
05th Jul 2022 19:10

You are merely restating OP's original query and agreeing with AB's original response (which response I had myself agreed with - twice - and restated in the response to which you have responded). At least, that's how I read your remark.

Much more interesting, actually, is OP's follow-up query (3rd Jul 2022 @ 12:52). I don't believe AB's response thereto (although clearly Dulls agrees with it). There are statutory pretences if there's only one transferor (s266 refers). But nothing similar I am aware of where you have joint/simultaneous/same day settlors. And, in absence of that, I don't have a better answer than AB's/Dulls's, though it 'feels' (sorry, I know you don't like that) alien to the whole basis of IHT. (And if it happens on simultaneous death, there is a prescribed order of events.)

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Replying to Tax Dragon:
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By AB_85
05th Jul 2022 22:43

I agree there are no provisions similar to s266 re order of transfers when you have two settlors, albeit spouses. And the concept feels wholly antithetical given H&W are taxed independently. So I don’t think one can consider the transactions in order. Who goes first?

Presumably we both agree that the related party rules in s161 are in point? The company is controlled by husband and wife, so our starting point in establishing loss to the estate must be a per share value based on a 100% shareholding. What’s the end point? If we agree that we can’t inpute an order to the settlements, the options must be we treat the settlement made by spouse as simultaneous or ignore it?

My rationale was to hypothecate a much more radical change in ownership and work out the principle from there - because in the scenario we were discussing Dullard is right, there would only ever be a small discount in going below 75%. But what if instead we were going from H 50% W 50% to say H 20% W 20% Trust 60%

Well, running through the two options, we are either going from 100/100 to 40/100 (pro rata between H&W on a per share basis) or from 100/100 to 70/100? And the second method feels completely wrong, because it wouldn’t include any discount for loss of control on either H or W’s transfer, even though they are clearly now minority shareholders. That must understate the transfer of value.

I think Dullard is probably right, in the sense that it seems at odds with some of the central tenets of IHT because it isn’t really an IHT issue, but one of maths and valuation principles.

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Replying to AB_85:
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By Tax Dragon
05th Jul 2022 22:22

You say 'the estate' as if it were joint. On what basis? S261 is just a valuation rule for determining the quantum of a ToV by an individual, no more. Further, if you take account of the joint estate, then Dulls's answer when wife gifts 26 shares is correct - which you, MUL and I agree is not the case.

In the example, the joint estate reduced by £408K but wife's by only £308K, and the measure of the CLT is that £308K reduction to W's estate.

Is it really the case that, if, instead of W 26 H 0, the score is 25-1, then the combined CLT is £100k higher?

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Replying to Tax Dragon:
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By AB_85
05th Jul 2022 23:02

Poor choice of words perhaps, but I wasn’t referring to a joint estate at all. Rather to the estate of the transferor, whoever that might be.

I agree that s161 is just a valuation rule for establishing T of V

I think there are 3 options, as I went through (note I edited my post slightly while you were writing yours):

1) the method I set out in my second post on the thread - which assumes both settlements are made simultaneously

2) Ignore the settlement made by the spouse on the same day - I don’t see how the maths on this can ever add up without disregarding s161 altogether

3) Impute an arbitrary order to the settlements (analogous to s266). Either H or W goes first. Which seems to me the most wrong of all as then you really are inferring the concept of a joint estate

I don’t see any other possible analysis and 1) is the only one that produces a satisfactory answer to my mind

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Replying to Tax Dragon:
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By AB_85
05th Jul 2022 23:39

Forgot to comment re Dullard’s worked example. You only get to that £100k diff in CLT (based on 24-2, not 25-1) by applying an unrealistic discount rate (which Dull acknowledges).

I’m out because it’s late and while of interest this is all highly theoretical

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