PETs: The “Do’s” and “Don’ts and “Points to Note”

PETs: The “Do’s” and “Don’ts and “Points to Note”
A gift from one individual to another constitutes a potentially exempt transfer (PET) for inheritance tax (IHT) purposes (post Finance Act 2006 most gifts into trusts are chargeable lifetime transfers (CLTs)). If the individual donor survives for seven years from the date of the gift no IHT arises on the PET. Should death occur within this seven year period IHT will in principle be payable (at 40%) unless the PET falls within the donor’s nil rate band (i.e. £325,000 for 2009/10).


Whose Liability is it anyway?


Where an IHT liability does arise, it is to be appreciated that it is primarily the liability of the donee (i.e. recipient of the gift) and not that of the donor. This can precipitate cash flow problems for the donee; consider term assurance to meet the liability.


Surviving for More Than 3 Years


Due to taper relief, the longer the donor survives within the seven year period the lower the IHT liability. Despite the common misconception that taper relief reduces the quantum of the gift it in fact reduces the quantum of the IHT liability.


Example 1


Tom gifts an asset (X) worth £20,000 to his son, Michael, on 1st January 2006 (having used up his nil rate band). Tom dies on 5th September 2009. Michael’s IHT liability equals [40% x £20,000] x 80% (taper relief) i.e. £6,400. For deaths of more than 3 years but not more than 4 years taper relief is (as above) 80%; then 60%; then 40%; and finally 20% for deaths of more than 6 years but not more than 7 years.


PETs and Recession


It is normally the value of the PET at the date it is made that determines the amount of any IHT charge. In many cases the current recession has caused property values to reduce. Thus, the value of a gift made by the donor may be less at the date of death than at the date the gift was made. In such cases the donee may make a claim to have the IHT liability calculated on the reduced value at death.


Beware the Non-PET


It is often thought that where one individual benefits another individual, any such gift will qualify as a PET; this may, however, not always be so.


Example 2


Mary is very fond of her uncle George who has always wanted to go on a Caribbean cruise. For his 70th birthday, as a surprise, Mary pays for George to go on the cruise at a cost of £10,000. Such a gift is not a PET but a CLT and, if Mary had exhausted her nil rate band, a 20% IHT charge would arise on the £10,000.Had Mary simply gifted £10,000 to George, such gift would qualify as a PET (although not perhaps the same surprise value!!).


Another classic example would be the payment by a grand-parent of a grand-child’s school fees.


Lifetime PET or Gift by Will?


Whilst in general it is a good idea to make lifetime PETs (hopefully surviving seven years), thus reducing the quantum of the death estate, this normally effective strategy is not always appropriate vis a vis other taxes.


For example, if property owned by the donor qualifies for, say, business property relief (BPR) at the 100% rate it may be more tax efficient to gift such property by will rather than gifting in lifetime. Whilst a lifetime gift may precipitate no IHT liability (due to the 100% BPR) a capital gains tax (CGT) liability will arise unless hold-over relief applies (which typically it will; i.e. any immediate CGT liability will be deferred). However, if the property had been left by will there would, on death, have been no IHT charge (due to BPR) and a CGT free uplift which would not be the case where a lifetime gift had been effected.


Practical Tip


Always ascertain if the gift to be made is a PET or CLT and ensure that the donee appreciates that any IHT liability arising from a PET is primarily his/her’s. Beware making a PET of assets which qualify for, inter alia, BPR, and don’t forget to consider making a claim if the gifted asset’s value falls between date of gift and death of donor.


Malcolm Finney