View the related Tax Guidance about Potentially exempt transfer (PET)
Potentially exempt transfers
Potentially exempt transfersThis note explains the concept of a potentially exempt transfer (PET) and describes the tax treatment. A PET is not taxed when it is made and will become either taxable or exempt at some point in the future. For information on transfers which are taxed at the time they are made, see the Occasions of charge and Chargeable lifetime transfers guidance notes.What is a PET?A PET is defined as a transfer of value (a gift), which:•is made by an individual during his lifetime•would otherwise be a chargeable transfer, and•satisfies certain conditions relating to the transferee, which differ depending on whether the transfer was made before or after 22 March 2006. These conditions are explained belowIHTA 1984, s 3AThe transferThe definition covers a personal gift. It also includes a ‘transfer of value’ which is not an actual transfer of property but results in an increase in value of the estate of another individual. This might arise, for example, when rights attaching to shares or property are altered.The transferorThe term ‘individual’ includes the beneficiary of a qualifying interest in possession (QIIP). See the Qualifying interest in possession guidance note. This is because such a beneficiary is treated for IHT purposes as beneficially entitled to the underlying trust property. Consequently, in addition to an outright gift from an individual, a PET is made when a QIIP comes to an end and the trust property passes to a transferee who meets the conditions described below. Note that it
Lifetime planning ― an overview
Lifetime planning ― an overviewLifetime planning from an inheritance tax (IHT) perspective is principally associated with lifetime giving. The broad aim is to reduce the value of a person’s estate and consequently the IHT charge on death.In addition to lifetime giving, the planning might also involve structuring asset ownership to ensure tax efficient investments and enhancing 100% relief from IHT wherever possible (see the BPR overview and Agricultural property relief (APR) guidance notes). Lifetime IHT planning should also involve making best use of all IHT exemptions. See the Exempt transfers for IHT and Dispositions that are not transfers of value guidance notes.Lifetime planning involves, firstly, a thorough fact-find exercise to uncover the full extent of the client’s assets, previous gift-making history and family circumstances. See the Fact finding - inheritance tax planning guidance note.Secondly, it will be necessary to ascertain the client’s objectives and consider the best way in which these can be met.Lifetime planning for wealthier clients usually involves a combination of lifetime gifts and planning through a Will. The two aspects should not be dealt with in isolation. It is essential to have regard to the terms of a Will if lifetime gifts are contemplated and vice versa. Even if a client does not pursue any lifetime planning, he should at least consider making a Will. See the An introduction to Wills planning guidance note.Similarly it is crucial to get the priorities right. Before embarking on any lifetime giving it is essential to have regard to the
Exempt transfers for IHT
Exempt transfers for IHTThis note will explain when transfers are exempt. However, it should be noted that some exemptions do not apply in relation to the estate charge on death.Exempt transfers ― summaryTotal exemptionA transfer is exempt from IHT where it is:A potentially exempt transfer (PET) which is made seven years or more before deathIHTA 1984, s 3A(4)To a spouse or civil partner who is domiciled in the UKIHTA 1984, s 18Classified as a small giftIHTA 1984, s 20Classified as normal expenditure out of incomeIHTA 1984, s 21A gift to a charity or registered clubIHTA 1984, s 23A gift to a political partyIHTA 1984, s 24A gift to a housing associationIHTA 1984, s 24AA gift for national purposesIHTA 1984, s 25A gift to a maintenance fund for a historic buildingIHTA 1984, s 27A gift to an employee trustIHTA 1984, s 28Partial exemptionThe above transfers are totally exempt from IHT. The following are exempt up to a specified amount:A transfer to a spouse or civil partner who is not domiciled in the UKIHTA 1984, s 18A transfer that benefits from the annual exemptionIHTA 1984, s 19A gift in consideration of marriage or civil partnershipIHTA 1984, s 22Mature PETsWhere a lifetime transfer is treated as potentially exempt at the time it is made, because it is a PET, that transfer becomes fully exempt if the donor survives for seven years or more after making it. For more
Gifts with reservation ― overview
Gifts with reservation ― overviewIntroductionA gift with reservation (GWR) arises when an individual ostensibly makes a gift of his property to another person but retains for himself some or all of the benefit of owning the property. The legislation defines a gift with reservation with reference to ‘enjoyment of the property’. If possession and enjoyment are not effectively transferred, then regardless of legal ownership, the property is taxed as part of the estate of the donor.The purpose of the GWR provisions is to prevent a taxpayer from reducing the value of his estate subject to IHT whilst at the same time continuing to benefit from the property given away. Often a client’s initial approach to inheritance tax planning will be to put a significant asset, usually his home, ‘in the name of’ a child or other eventual beneficiary under the misapprehension that it will remove the asset from assessment to IHT on his death. The GWR anti-avoidance rules render such action ineffective for IHT.The term ‘gift with reservation’ and its abbreviation GWR are interchangeable with the term ‘gift with reservation of benefit’ and its abbreviation GROB.Definition of a gift with reservationThe legislation is not included in the main Inheritance Tax Act 1984 but in Finance Act 1986. It was included as an afterthought when it was recognised that the introduction of potentially exempt lifetime transfers (a new provision when inheritance tax replaced capital transfer tax) might promote avoidance unless there was a measure to prevent the continued ‘enjoyment’ of
An introduction to inheritance tax (IHT)
An introduction to inheritance tax (IHT)This guidance note provides a background to IHT and the basic principles.Background to inheritance taxInheritance tax is, essentially, a tax on gifts. This typically arises when a person dies and all the property that they own (their ‘estate’) passes to beneficiaries. An individual may also transfer their assets to others during lifetime. This could be an outright gift of assets to another person or a gift into trust.Assets in trust are held by trustees for the benefit of others, whose entitlement to them is restricted in some way. Special inheritance tax rules apply to trusts to reflect the separation of legal and beneficial ownership.IHT is a tax on the donor ― the person who is transferring the asset(s). It is calculated with reference to their estate. It is not a tax on the beneficiaries, though what the beneficiaries receive may be reduced by the amount of tax. This position contrasts with the law in certain other jurisdictions where ‘death duties’, gift tax or the equivalent are a tax on the people receiving the property and is taxed in accordance with their status or wealth. Clients who receive an inheritance often ask if they have to pay tax on it. Generally, the answer is ‘no’, because any tax due has fallen on those administering the estate or trust, and will have already been paid. However, this may not always be the case, as a lifetime gift may give rise to IHT if the donor dies
Associated operations
Associated operationsUnder the inheritance tax rules, a settlor makes a disposition of his property where he transfers ownership of it to another person. In addition, a disposition is also made where it is effected by associated operations. So where associated operations result in a transfer of the beneficial ownership of property by the settlor and a fall in the value of his estate, he is treated as having made a disposition resulting in a transfer. That transfer is either a chargeable lifetime transfer (CLT) subject to the lifetime charge to IHT or a potentially exempt transfer (PET).The rules on associated operations exist in order to prevent the avoidance of IHT by the means of splitting a single transfer into a series of transactions in order to reduce the amount of IHT due. The rules will only apply in cases which would not be regarded as a disposition of property in its ordinary sense.For example in Rysaffe Trustee Co, a settlor made five discretionary trusts and transferred shares to each trust. HMRC argued that the creation of all the trusts constituted associated operations. Thus the settlor had to be regarded as having transferred all the shares at once for the purposes of calculating the 10-year charges on each trust (thereby resulting in more tax being payable). The Court of Appeal rejected this assertion on the grounds that a disposition in the ordinary sense of the word had occurred when the shares were settled. The shares in each settlement were therefore
Qualifying interest in possession
Qualifying interest in possessionSignificance of a qualifying interest in possessionWhere a beneficiary’s entitlement to trust property satisfies the definition of a qualifying interest in possession (QIIP), the trust property falls into the beneficial entitlement regime for inheritance tax purposes. See the Taxation of trusts ― introduction guidance note.The inheritance tax treatment of trusts falls into two broad categories:•beneficial entitlement (bare trusts and qualifying interests in possession), and•relevant property (non-qualifying interests in possession and discretionary trusts)Prior to 22 March 2006, all interest in possession trusts were included in the beneficial entitlement category, but changes introduced by FA 2006 transferred most lifetime interest in possession trusts into the relevant property category. Hence the beneficial entitlement treatment only applies to qualifying interests in possession. See the March 2006 changes to trust taxation guidance note.IHT consequences of beneficial entitlementThe term beneficial entitlement refers to the inheritance tax treatment under IHTA 1984, s 49, which provides that a person beneficially entitled to a (qualifying) interest in possession in settled property shall be treated for the purposes of this Act as beneficially entitled to the property in which the interest subsides. This means, in effect, that the trust property is taxed as if it belonged outright to the beneficiary. All other trust property is subject to the special inheritance tax rules of the relevant property regime. See the Definition of relevant property guidance note and other notes in that sub-topic. In summary, the consequences of the beneficial entitlement category are:•the full value
Opting out of the pre-owned asset tax charge
Opting out of the pre-owned asset tax chargeThis guidance note considers the circumstances in which an individual may wish to opt out of the pre-owned asset tax (POAT) and the how this impacts their inheritance tax position.For discussion of the regime generally, see the Pre-owned asset tax overview guidance note.An individual subject to pre-owned asset tax (POAT) can make an irrevocable election to opt out of the pre-owned asset tax regime in relation to a particular asset. The downside is that the asset will then form part of the estate for IHT purposes. Separate elections can be made for different assets.Effect of election ― land and chattelsIf it is to be made at all, the election must be made for the first tax year in which an individual would otherwise be chargeable to pre-owned asset tax by reference to the enjoyment of the asset in question, ie the occupation of the land or possession or use of the chattel, or any other property for which it has been substituted. The effect of the election is twofold.Firstly, the pre-owned asset tax charge will never apply to the individual’s enjoyment of the asset concerned or any asset which is substituted for it. Secondly, so long as the individual continues to enjoy the property (or substitute property), they are treated for IHT purposes as having made a gift with reservation of benefit, with the following results:a)if, at the time of the individual’s death, the property continues to be subject to a
March 2006 changes to trust taxation
March 2006 changes to trust taxation22 March 2006 was the day of the 2006 Budget which, without any warning or consultation, made sweeping changes to the IHT treatment of trusts. The date represents a watershed in the IHT treatment of trusts since many of the key changes took immediate effect. To work out the correct IHT treatment of a trust today, it is necessary to look at whether it was made before or after 22 March 2006.Before 22 March 2006, trusts fell into the following three main categories for IHT purposes:•relevant property (RP) trusts, which were usually discretionary trusts•interest in possession (IIP) trusts, and•accumulation and maintenance (A&M) trustsOn that date, the relevant property regime (RPR) was extended to nearly all new lifetime trusts, whether in discretionary, IIP or A&M format. Similarly, lifetime additions of property to all existing trusts (with the exception of disabled trusts, bare trusts and some premiums paid in respect of life policy trusts) would also be within the RPR. Transitional rules were given to existing IIP and A&M trusts, but with a view to bringing those trusts within the RPR in the longer term. The aim was to try to make trusts less attractive for IHT purposes, though many other benefits to using trusts remain (see the Why people use trusts guidance note).The main disadvantage of making a relevant property trust is that the settlor incurs an immediate IHT charge, if the value of the settlement exceeds his cumulative nil rate band,
Partitioning trust funds
Partitioning trust fundsOverviewPartitioning a trust fund refers to splitting the fund between the income and capital beneficiaries. This will terminate the trust. This guidance note looks at how and when a trust can be partitioned and the tax effects of this. Partitioning a trust should be done by deed. Under the Legal Services Act 2007, writing deeds is a ‘reserved legal activity’ and should only be undertaken by a person authorised to do so under that Act. See the Reserved legal services guidance note for further information.Resettlements are covered in the Resettlements and sub-funds guidance note and variations are covered in the Variations guidance note.This guidance note deals with the position in England and Wales only. See Simon’s Taxes I5.8 for details of the provisions affecting Scotland and Northern Ireland.Reasons for partitioning a fundReasons for partitioning a fund might include:•the reason that the trust was set up no longer being relevant•the needs of a specific beneficiary•tax mitigation•the wish to reduce trust administration costs, or•a breakdown in relations between the beneficiariesWhere the beneficiaries want to bring the trust to an end by mutual agreement, whether or not the trustees agree, this can be achieved under ‘the rule in Saunders v Vautier’, provided the conditions set down in that case are met. The rule in Saunders v VautierFixed interest trustsThe rule in Saunders v Vautier provides that beneficiaries are able to bring the trust to an end between them without the agreement of the trustees where:
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