Can gifts be tax-efficient for passing on assets?

The majority of people would rather pass their money or assets on to loved ones, rather than to the tax authorities, after their death. To maximise the amount their heirs will receive, many may consider giving away assets while they are still alive. However, tax agencies worldwide are wise to potential abuses and have implemented precautions to ensure that gifts are not used as a means to evade tax.

Each country has rules regarding gifts, in most cases designed to prevent individuals simply transferring assets during their lifetime to avoid their wealth becoming subject to inheritance tax. In most countries, tax treatment is governed by national law in the country where the gift is received. However, many basic principles are identical across European countries.

Inheritance tax can be heavy, particularly when transferring assets to non-immediate family members. In Luxembourg, inheritance taxes are levied on the entire estate of individuals deemed at death to have been residents of the grand duchy – in other words, if Luxembourg is their domicile and centre of their activities.

Real estate, as well as assets treated as ‘movable property’ that are located abroad and taxable on the basis of citizenship, are exempt from taxation in Luxembourg, but other movable property located in other countries is taxable in the grand duchy.

Compulsory heirship rules

Inheritance tax rates in Luxembourg range from 0% to 48%, increasing with the value of the estate and distance of the relationship between the legator – the person leaving the legacy – and the heir. Rates are lower for bequests to spouses, children and other close relatives. The grand duchy’s inheritance tax rates are not conspicuously higher than those of other countries; in France, for instance, top rates can exceed 60%.

Luxembourg’s inheritance rules, like those of other civil law countries, include compulsory heirship provisions that bar individuals from cutting off their children without any inheritance, setting minimum proportions of the estate they must receive on their parent’s death.

At least 50% of the estate must go to the children if there is one child, 67% if there are two and 75% for three or more.

According to the law, at least 50% of the estate must go to the children if there is one child, 67% if there are two and 75% for three or more. This can create problems amid complex family arrangements, such as involving second (or subsequent) marriages and stepchildren.

Gifting assets during one’s lifetime is a useful option for limiting the estate’s inheritance tax liability, or to circumvent the compulsory heirship rules, but it depends on the individual’s ability to surrender the titular ownership and use of the assets. The authorities are alert to arrangements aimed at reducing tax liability, and insist that one cannot retain benefits from an asset that has been gifted.

Tax rates applicable to gifts

In Luxembourg, tax is levied on gifts made during an individual’s lifetime, although it is usually much lower than the liability under inheritance tax rules. For gift tax purposes, the location of the recipient and donor are irrelevant; tax is payable on a proportion of the asset’s market value. If this is unclear, the asset must be subject to an independent valuation.

The current rates are:

• • 1.8%-2.4% on gifts to individuals in the donor’s direct bloodline (children, grandchildren, etc.).
  • 4.8% between spouses and civil partners of at least three years’ standing.
  • 4.8% on gifts to charitable causes, including certain public institutions, foundations and non-profit organisations.
  • 6% between siblings.
  • 8.4% on gifts involving uncles and aunts, nephews and nieces, and adoptive parents and children.
  • 9.6% on gifts involving great-uncles and great-aunts, great-nephews and great-nieces, and adoptive grandparents and grandchildren.
  • 14.4% on gifts between unrelated persons.

The tax rates are reduced for gifts made on the occasion of marriage or contracts made in ‘contemplation’ of marriage, such as property settlements.

Gifts of ‘immovable property’ – land and buildings – may be subject to an additional transfer duty of 1%. To comply fully with the law, a list of gifts should be drawn up, witnessed and certified by a notary to create an official document.

Gifts to certain types of educational institutions can be made tax-free.

‘Hand-to-hand’ gifts

There are exemptions. Gifts to certain types of educational institutions can be made tax-free. A more significant exemption is for gifts known as a ‘don manuel’ – literally from hand to hand – that do not need to be registered with a notary and entail no tax, unless the donor dies within the same tax year in which the gift was made. In such cases, the gift is treated as part of the donor’s estate for inheritance tax purposes.

The hand-to-hand gift is reserved for specific items such as money, jewellery or artworks; the term is symbolic rather than necessarily restricted to objects that can be physically handed over. However, even these under-the-radar transfers still require care in order to avoid problems.

They can be treated as taxable if the recipient declares the gift spontaneously to the tax authority, or if it is part of a pattern of gifts to the same person. They will also attract the attention of the tax authorities if made after a request for information from the recipient, or if the agency plans an inspection or audit. And official attention will be drawn by any suspicion of deliberate tax evasion.

Similarly, excessive efforts to circumvent the compulsory heirship rules may also be noticed. Giving away all your worldly goods to prevent your wayward children from inheriting may not survive legal scrutiny.

Pitfalls of using trusts

Another problem is that hand-to-hand gifts may create discrepancies in the legacies left to family members, potentially a recipe for family divisions and resentment. So while they may seem a straightforward method for transferring assets, always bear in mind the potential complications and drawbacks.

Alternatives to gifts exist that can both mitigate compulsory heirship requirements and inheritance tax liabilities, such as placing assets in a foreign trust. However, this is complex and fraught with potential pitfalls – and certainly not to be undertaken without expert advice. Also consider that with assets that are not subject to inheritance tax, there is no need to give them away during your lifetime.

Gifting can be useful for placing a portion of your assets outside the reach of the tax authorities before your death. But be careful: failure to follow the rules will defeat the purpose. Never forget that the information provided at such moments should always be considered based on your personal situation and its impact may change with new legislation.