Irish Capital Acquisitions Tax (CAT) applies to gifts and inheritances at a rate of 33%. There are various reliefs, thresholds and exemptions available which can reduce this tax. However, where an Estate is substantial, then the tax can still be significant.
As CAT is a liability of the beneficiary, probably the most common issue is how to pay it. The benefactor can of course arrange to discharge the tax too though this method can be expensive, giving rise to further CAT. Discharging the beneficiary’s tax bill is regarded as a further additional taxable gift or inheritance. In practice, this can result in a further transfer of upwards of 40% of the original value - which may not even be possible or indeed desired.
In a simple world, the beneficiary can use some of the assets received to pay the tax. This is easy with cash but more difficult where the assets are real property or private company shares. It may not even be desired or possible to break up an asset, especially one that has been in family for generations, to pay a tax bill.
Here are 3 options for dealing with this issue which can significantly reduce the tax costs on inheritance.
This deals with the simple enough scenario where the inheritance to be fully (beneficially) owned by the beneficiary. A trust structure might be appropriate in certain instances and can also defer the CAT but will have other tax impacts.
1. Company funding the tax
Inheritance of family company, can often trigger a CAT charge, even assuming the specific CAT relief for business is available. How is the tax funded, assuming this is the only family wealth? The difficulty here is that the value is stuck in the company and this immediately begs the age old question as to how to get money out of a company tax efficiently. The easiest way is often for the company itself to fund the tax from its own resources. However, usually any payment from the company will by default be regarded as income. This can result in an effective tax rate for the new owner at up to 55% on the proceeds. This treatment can apply to not only dividends but also proceeds on a buyback or redemption of shares.
However, under a specific provision of Irish tax law, Capital Gains Tax (CGT) treatment can apply to certain redemption or buybacks. The main condition is that the CAT arising on inheritance must be discharged using the proceeds. And the shareholder could not have otherwise discharged the CAT without undue hardship.
For the shareholder, the receipt will be within the scope of Irish CGT. In practice, the tax here (if any) should not be significant. This can be a very valuable relief especially compared to a dividend. For example, for a CAT liability of €1 million on shares, it would be necessary for company to pay dividend of up to €2.2 million so there is enough after tax proceeds to pay the CAT.
2. Gift rather than inheritance
Another solution for funding the CAT would be to make a gift, rather than wait for an inheritance.
Gifts are sometimes discounted as they give rise to Irish CGT for the owner, whereas there is no such taxes on death. CAT arises on both gifts and inheritances.
However, it can be more efficient to make a gift and incur the CGT cost rather than wait to pass the assets as inheritance.
This is because Offset Relief can be available whereby the beneficiary can offset the CGT against their own CAT bill on the acquisition. As a result, the original owner can fund the CAT without additional cost. The beneficiary will need to retain the assets for 2 years.
Depending on the facts, this approach can result in a significant reduction in tax compared to an inheritance. This is because the offset benefit for the beneficiary is not taxed as a gift.
For example, if the value of investments to be transferred are €10 million (with nominal base cost) then the overall tax saving here can be up to €1 million. The €3.3 million to pay the CGT can eliminate the beneficiary’s CAT bill (assume no remaining threshold) and this value achieved is not taxable. In contrast, the transfer of equivalent value to the beneficiary as an inheritance (being the €10 million shares and €3.3 million cash) would result in total tax bill of €4.3 million. This example illustrates the maximum relief available where there is nominal CGT base cost in the assets. This option should always be considered in this scenario.
The Offset Relief can also apply to certain income type taxes such as on life assurance products and Irish funds. Transaction taxes, such as Stamp Duty, may apply on lifetime transfers and the calculations should factor these in too.
3. Take out a specific Insurance Policy
Invest in a specific Life Assurance Policy (known as Section 72 policy). These can be tax efficient because on pay-out, the proceeds of the policy used to fund the CAT are not taxable as part of the Inheritance. This can result in a considerable tax saving.
Client CASE - Mary
Mary’s estate is valued at €1.4m – comprising investment property worth €1m and regular life policy cover of €400k. On her death, the estate is left to her nephew, David.
David’s Irish CAT bill will be €462k (Note). David may also have the problem of funding this tax as it is greater than the insurance proceeds received – he may need to sell the property.
If instead, the policy was a specific ‘Section 72’ policy then CAT on the property of €333k could be mainly covered by the insurance proceeds and this element of the proceeds will be CAT exempt. The balance of the policy will be subject to CAT in the normal manner, working out around €22k, but at least David will have ready cash to pay this liability.
The difference in the two scenarios is a saving of over €100k in tax. This also eliminates a tax funding headache for David and there will be no need to sell the property.
Note - value of €1.4m @ 33pc – for ease, lets assume he has no tax free threshold. It is small in any case for non parental relationships
These policies can have a reputation of being expensive and a thorough financial and tax evaluation should be undertaken. A common misconception here is the tax is being funded by the insurance company, but this is not the case. The tax saving on a Section 72 policy is an exchequer funded tax relief.
The potential return, along with tax saving, needs to be balanced with the opportunity cost of the premiums contributed. And of course, along with the other variables, the tax saving can never be guaranteed due to the ever changing nature of tax law and tax rates.
A Section 72 policy should be seriously considered if:
You like an assurance type product in your portfolio and your other assets would trigger a significant CAT bill for the recipients or
The preference is that your Estate is retained by the beneficiaries rather than sold to pay the CAT bill.
Other thoughts
The above options would all need to be considered and planned for whilst the owner is still alive. This planning should be in conjunction with general CAT advice. As noted above there are various reliefs available and many owners will wish to ensure these apply, especially Agricultural or Business Relief. They may also consider other longer-term strategies such as co-investment opportunities with beneficiaries; so that growth and value accrues to them directly.
A holiday chalet or a business?
