With the Autumn Budget fast approaching, uncertainty around potential changes to inheritance tax and lifetime gifting rules is rising. Rumoured caps or wider reforms are prompting many clients to revisit their estate plans. In this article, Andrew Godfrey, Partner, and Sarah Ahchoon, Senior Associate in the Private Client team at Russell-Cooke LLP, outline the key tax considerations advisers should keep in mind when discussing lifetime gifts with clients.
With the Autumn Budget fast approaching, rumours of potential changes to Inheritance Tax planning and the seven-year rule on lifetime gifting continue to circulate. Whether this might take the form of a lifetime cap on gifts, a reduced allowance, or a complete overhaul, many clients are reviewing their estate planning options and considering making gifts sooner rather than later.
For those with assets such as holiday homes abroad, now might be the time to review their positions. Gifting cross-border properties may be a useful tax planning option. Often, multiple family members enjoy using the properties, and that can be useful for UK tax planning. However, it is essential to look at both the position in the country where the property is located and that of the owners themselves. We often see that tax and succession complications come to light only once it’s too late. Local advisors in overseas jurisdictions frequently operate in isolation using their tried and tested local knowledge only, with limited understanding of how UK tax rules interact with their own domestic regimes. As a result, property owners are sometimes encouraged to make gifts of overseas properties without fully considering the cross-border implications of the gift.
In this article, we examine some of the practicalities and the succession and taxation considerations involved in gifting second homes in France, Italy, and Spain, where the property owner (the donor) is a UK long-term tax resident.
Practicalities
From an English point of view, the transfer of an interest in a property can happen just by signing a deed, and this can have effect for tax purposes. Furthermore, the actual transfer of the legal property title happens with the submission of the appropriate form to the Land Registry. The submission can happen with the assistance of a lawyer, which though always advisable is not an absolute requirement. This is not the case with Italy, France and Spain which all require a (locally qualified civil-law) notary to be involved with a transfer of a property interest.
The notary will prepare a deed as part of formalising the transfer of the property from the donor to the recipient of the gift (the donee). The signing of the deed by the parties traditionally involves physical presence at the notary’s office, or an attorney can be appointed by a power of attorney to sign on behalf of a party. The notary can also advise on whether there is any matrimonial property regime in play and its effect on the transfer.
In France, the notary’s fees are on a fixed scale based on the property value. Typically, these are 1-2% plus VAT of the value of the property and disbursements (which can include the cost of translations and powers of attorney). In Spain, the notary’s fees are based on the value of the property. For example, if a property is valued at €1 million, the fees are between €950 and €1k. In Italy, there are no fixed notary costs, and the fees depend on the value of the property and the particular notary involved.
In terms of the timeframe, the transfer process typically takes about two months to complete in France and Spain, and can take about one month in Italy.
Only once the deed has been signed by the relevant parties will it be effective for tax purposes. Taxes are then paid (see further below) and the transfer of the property is registered at the Land Registry.
It is important to note also that although clients may engage the services of a notary directly, language can still often be a barrier. An advisor qualified in both countries can therefore be beneficial in explaining the process and terms, and advising on the dual cross-border aspects of the transfer and also liaising with the principal parties.
Taxation – care needed
When considering a gift of an asset abroad, the donor must not only consider the tax consequences of the gift from a UK perspective, but also the tax consequences of making the gift from the perspective of the country where the property is located.
In some instances, a transaction can give rise to a risk of double taxation with limited or no availability of obtaining a credit for the tax paid in either country. In some circumstances, relief may be available under a treaty. Great care is therefore needed.
By way of cautionary example, in France, Spain and Italy, an usufruct arrangement is a common form of local estate planning. This involves the donor making a gift of their property to another person (often their children) but retaining the right to enjoy it either by occupying or, if the property is rented out, the right to receive the rental income. On the death of the donor, the property then passes in its entirety to the donee. The concept of an usufruct bears many similarities to a life interest trust under English law, but at its core is essentially different. Whilst an usufruct arrangement can offer tax advantages in the country concerned, it can cause great problems from a UK perspective.
We consider below the tax consequences of making a gift of a property abroad from a UK perspective and that of the country where the property is located.
Taxation – UK
At present, gifts are exempt from inheritance tax if the donor survives seven years from the date of the gift. Having said this, if the donor continues to live in or benefit from the gifted property, the gift may be treated as a “Gift with Reservation of Benefit,” meaning the property’s value will still be included in the donor’s estate for inheritance tax purposes and the 7-year rule will not apply. There are ways of ensuring that a gift is not subject to a reservation of benefit and advice must be taken at the time. The rate of inheritance tax is 40%, though tapering of tax arising can apply if the gift is made more than three years before the date of death.
Capital gains tax may also apply on a gift of foreign property, and advice needs to be taken.
Double tax agreements are in place between the UK and European countries including France, Italy, and Spain which may influence how inheritance and capital gains taxes apply. However, these arrangements can vary depending on the specific terms of the agreement and on whether a transfer occurs during a person’s lifetime or on death. Key to understanding how these will work with a property transfer is understanding which taxes can, and those which cannot, be set off against each other. There are often local taxes involved with a property transfer that are not deductible from UK tax.
Taxation – Italy
In Italy, the process of gifting property is similar to that of a sale, but just without monetary exchange. Transaction taxes are calculated based on the cadastral (tax) value, which is typically lower than market value. Donors gifting property to children or a spouse benefit from a lifetime €1 million exemption from succession tax per donee, with a 4% rate of tax applied to any excess. In contrast, in the UK the inheritance tax allowance of £325,000 renews every seven years.
Italian capital gains tax does not apply to gifts, though a transfer tax of 3% applies to gifts of second homes. The donees will need to be aware of the annual property taxes due on second homes ((which will depend on various factors involved, such as where the property is located) which will need to be paid.
Taxation – Spain
Spain’s succession/gift tax system is regionally governed, with rates and exemptions varying across its 17 autonomous regions and two autonomous cities. Generally, gifts of a main residence to descendants attract significant reductions, but gifts of holiday homes or to distant relatives are taxed more heavily. The tax rates are progressive (currently up to 34%) and depend on the value of the property.
Capital gains tax may apply to the donor if the property has appreciated in value, with rates of 24% of the gain for UK residents (more than the 19% rate for EU/EEA residents). Municipal taxes on land value increase and other local charges may also apply, and clients often struggle with regional compliance.
Taxation – France
The gift of property in France is subject to French gift tax. The tax is payable on the market value of the property at the time of the gift. Each child has an allowance of €100,000 per parent which renews every 15 years. For example, a gift by both parents to their two children allows a gift of up to €400,000 to be made free of tax. If prior gifts to the same children were made within the last 15 years, the allowance is reduced accordingly.
A progressive rate then applies to the excess above the available allowance: 5% on the first €8,072, rising to 45% on over €1,805,677. No French capital gains tax is charged on the transfer. However, French Stamp Duty does apply to gifts of property.
Succession
England does not have a forced heirship regime, and a person can leave their assets to whomever they like (subject to any claims that could be made under the IPFDA 1975 for reasonable financial provision). However, in contrast to English law, France, Italy, and Spain have forced heirship regimes. Under a forced heirship regime, a person must leave part of their estate on death to close family members (known as the reserved share). The proportions vary depending on the country concerned and the number of children. When making lifetime gifts, donors can neglect to consider the effect of the gift on the succession of their estate when they die. That is, the children entitled to a share of the estate on death may dispute a significant gift made by the deceased donor and call for it to be returned to the estate (known as ‘clawback’).
In Italy, close relatives may challenge a lifetime gift up to 20 years later and clawback the property, even if the property has been sold. In France there is no such time limitation for making such a claim.
Conclusion
As the autumn Budget looms, gifting overseas property may be an efficient and effective tax planning exercise, but it requires careful planning and cross-border advice. While local rules may offer tax efficiencies for that jurisdiction, they must always be weighed against UK tax consequences. Forced heirship laws, regional tax variations, and differing interpretations of estate planning arrangements can all complicate matters.
Russell-Cooke’s cross-border team of Italian, Spanish, French and English qualified advisors regularly advise on gifts of properties to ensure they are structured effectively and that tax risks across borders are mitigated.