In my previous blog (http://awbclaw.blogspot.co.uk/2015/05/do-some-pets-bite-part-1.html) I looked at Potentially Exempt Transfers (“PETS”) and how a recipient of a gift can find themselves with an unforeseen Inheritance Tax (“IHT”) liability if a PET is made by someone who does not survive seven years from the gift.
I now want to look at PETs being made (or more accurately being treated as being made) when assets are held in certain types of trust.
A life interest trust is a type of trust in which assets are held by trustees for the benefit of a beneficiary (the “life tenant”) but with them ultimately passing to another beneficiary (the “default beneficiary” or “remainder man”).
The life interest can come to an end at any point depending on the terms of the trust but commonly comes to an end on the death of the life tenant. At this stage the capital of the trust is held for the default beneficiary. But what has this got to do with PETs?
In March 2006 the rules changed relating to how certain types of trust are taxed for IHT purposes. There are now two main categories of life interest trust that are important for IHT purposes. These are Immediate Post Death Interests (“IPDI’s”) and pre 22 March 2006 life interest trusts. An IPDI is essentially a life interest trust created on someone’s death. In these two categories of trust, if the life tenant’s interest is brought to an end during their lifetime, meaning that the assets pass to the default beneficiary then the life tenant is deemed to have made a PET.
In the example above, crucially, the life tenant needs to be aware that the life interest coming to an end is treated for IHT purposes as if they had made a gift as it means their tax free nil rate band (“NRB”) of £325,000 is being reduced. This has a knock on impact for any gifts they themselves make because these PETS may bear the burden of IHT if they fail (if the donor does not then survive seven years).
In conclusion, anyone benefiting from a life interest trust whose right to benefit has come to an end needs to take grate care from an IHT point of view when making gifts in the following seven years.
In my next blog I will continue to look at PETs and a strange situation of a PET being treated as being made without the donor knowing!