Explaining Potentially Exempt Transfers (pets)

Posted on April 6, 2008

A potentially exempt transfer or PET for short is one of the best known of the devices that can be utilised in the United Kingdom to save inheritance tax. In simple terms, ordinarily, if an absolute gift of money or property is made to a beneficiary and the donor survives for a period of 7 years, the original gift becomes tax-free for IHT purposes.

There are, of course, exemptions to this rule. The most common of which not everyone is aware relates to the gift with reservation rules. For instance, if a mother gifts her daughter her 3 Carat diamond ring (worth £50,000.00) and continues to wear the same then the gift will not be treated as a PET even if she was to survive the original gift by 20 years.

Where confusion often arises with regard to PETS is in relation to the way they interact with the nil rate band, which is, of course £300,000 per individual during the current tax year 2007/8 and is planned by the government to increase to £312,000 in 2008; £325,000 in 2009 and £350,000 in 2010.

This is particularly the case in relation to the taper relief available to PETS after a certain number of years have elapsed since a gift was made as per the figures below:-

Years between gift and tax and reduction in tax: 0-3 yrs - 0%, 3-4 yrs - 20%, 4-5 yrs - 40%, 5-6 yrs - 60%, 6-7 yrs - 80%.

It is not unusual in my experience for a child of a deceased person to state, for instance, that their deceased parent gifted them the sum of £100,000 just over 5 years before their death and as such, they should be entitled to 60% relief on the tax payable on the gift equating to £24,000 (60% of £40,000 tax payable)

I have to advise in this situation that as the original gift did not exceed the nil rate band in the first instance, the taper rules do not apply and any gift made within 7 years up until the date of death is purely treated as using up a cumulative part of the nil rate band available on death. Conversely, in the example set up above, if a lifetime gift of £400,000 had been made by the donor just over 5 years before their death then the £24,000 taper relief referred to above would have been available.

I would encourage Pets to be made where they can be afforded but please beware of the potential traps. As always, if in doubt, please take advice from a suitable qualified professional.

Paul Solomons - Solicitor and IHT specialist
http://www.iht-solutions.net
Commentary on all Inheritance Tax (IHT) matters.

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