The CGT rules for connected persons can often surprise those individuals who think they are making a gift with no tax consequences. These tax rules can impact gifts, the transfer of assets at less than market value, plus family transfers. Additionally, they can negatively impact capital loss claims and affect spouses and civil partners after separation.
What is a connected person?
A connected person is defined in the taxes legislation . Essentially, the group includes the following:
Because HMRC assume you may not act independently where you are connected, they apply stricter tax treatment to transactions between connected persons.
The CGT rules for connected persons stipulate that the market value applies to the asset concerned. Furthermore, this is regardless of the price agreed for the asset or where no price is actually paid because it is a gift. As a result, you could potentially face a taxable gains where you gifted an asset for no consideration.
Why do HMRC enforce these rules?
HMRC introduced these rules to prevent manipulation on the transfer of assets. So, without these rules, individuals could potentially create artificial losses, conceal gains within families and avoid CGT via the gifting of assets.
How capital losses work between connected persons
Usually when you realise a capital loss it can reduce your overall taxable gains. However, transactions between connected persons follow much stricter rules.
When you sell an asset at a loss to a connected person, HMRC restricts that loss. Consequently, you cannot utilise that loss against other capital gains and it becomes clogged. In other words, you can only use it against future gains involving the same connected person.
An example
Ross sells his shares in Geller Ltd to his sister Monica at a loss of £15,000.
He later sells an investment property and makes a £50,000 gain.
However, he cannot reduce this capital gain using the £15,000 loss resulting from the sale to Monica. Furthermore, he can only use it, when and if he later sells another asset to Monica at a gain.
Spouses and Civil Partners
Transfers of assets between spouses and civil partners usually create no gain and no loss. However, this rule applies only if they live together during the tax year.
As a result, no tax liability arises on assets transfers. The recipient spouse assumes the original purchase cost and the gain simply transfers with the asset. Furthermore, this relief overrides the normal capital gains tax rules for connected persons.
However where spouses or civil partners separate these rules can be overridden and this is where timing matters.
During the tax year of separation, the no‑gain‑no‑loss rule still applies. In other words, asset transfers remain tax neutral until 5 April.
What happens after the year of separation?
After the end of the tax year, the relief ends and the market value rules apply. As a result, this deadline can catch out many couples. Therefore, planning before the tax year ends can literally save you £1,000's in tax liabilities.
Once the next tax year begins, full connected person rules apply. Consequently, the market value replaces the actual sale price of an asset on transfer and gains become immediately taxable
Furthermore any losses become clogged if an asset is transferred at a loss. Therefore, spouses and civil partners are treated like any other connected persons.
Frequently these rules can commonly affect transactions involving family homes not covered by main residence relief, buy‑to‑let properties, share portfolios and business assets
Summary
The capital gains tax rules for connected persons punish mistakes more than most tax rules. Therefore, it's important to understand these rules as poor timing can create unnecessary and onerous tax liabilities.
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