How to avoid inheritance tax with Potentially Exempt Transfers - their advantages and potential pitfalls

Potentially Exempt Transfers (PETs) are a way to give away cash and assets free of Inheritance Tax. A PET is only free of Inheritance Tax if the donor lives for seven years after making the gift.

Gifts that count as a PET are gifts made to:

  • another individual
  • a trust for someone who is disabled
  • a bereaved minor's trust where, as the beneficiary of an Interest In Possession (IIP) trust (with an immediate entitlement following the death of the person who set up the trust), you decide to give up the right to receive anything from that trust or that right comes to an end for any other reason during your lifetime.

Once a PET has been gifted, its value is removed from the donor's estate.

The term "PET" is a shorthand description for gifts that may ("potentially") be considered outside an estate once a person dies. They are only "potentially" exempt from IHT because the donor has to survive for seven years after making the gift. After that, the value of the gift is outside the estate.

If the donor does not live for seven years there are measures that can ease this problem. Taper relief is a way of giving some tax breaks on the Inheritance Tax IHT bill when the donor dies between three and seven years after making the gift, but is available only to gifts valued at above the tax threshold.

  • Transfer up to 3 years before death: 100% of gift
  • Transfer 3 to 4 years before death: 80% of gift
  • Transfer 4 to 5 years before death: 60% of gift
  • Transfer 5 to 6 years before death: 40% of gift
  • Transfer 6 to 7 years before death: 20% of gift

A number of important points need to be made:

If tax is ever payable on the PET it is based on the value of the gift at the time it was made not on the value at the date of death or whatever else triggered off the tax payment. It is the donee of the gift who is liable to pay the tax.
The main advantage of this is that if an asset is likely to increase in value in future years it is possible to freeze the value for tax purposes by giving it away now rather than later. House prices in recent years are a good example of this. However, if the value of the asset goes down this can be a disadvantage e.g. some share prices.,br> The reduction is of the tax payable on the gift not the value of the gift. If the tax payable would have been £100,000 then after 4 years the tax liability has gone down to 80% and the tax payable then would be £80,000.
In working out the tax on the PET and on an estate, any PETs made within seven years of death are deemed to form the bottom of the estate and will therefore be set against the Nil Rate Band. This can have unexpectedly unfortunate results and leave some beneficiaries paying more than their fair share of Inheritance Tax.

A word of warning however, if someone gives something away but keeps the right to use it; this will not be considered a gift for IHT purposes. The asset will still be deemed part of the estate.

For further information contact Iain Robson at iain.robson@close-thornton.co.uk or call him on 01325 466461

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