Do some PETS bite? I am not referring to the fluffy animal variety but to a ‘Potentially Exempt Transfer’ more frequently known as a PET.
A PET is commonly made when an individual makes a gift to another individual and hopes to survive seven years from the date the gift is made. If successful the gifted asset is taken out of the person making the gift’s estate for Inheritance Tax (“IHT”) purposes. During the seven years following the gift the transfer is potentially exempt. This means that if the donor dies during this period the gift is no longer exempt and falls back into the equation when IHT is calculated in the donor’s estate. The failed PET, depending on its size, uses up some or all of the deceased tax free ‘Nil Rate Band’ (“NRB”) – currently £325,000. If the failed PET exceeds the NRB then tax becomes payable on it.
- •So put simply, if I give my friend Dave £400,000 (having not made any earlier gifts) then I die a year later penniless, Dave will have to pay IHT of £30,000 (£400,000 – £325,000 = £75,000 @ 40%). Crucially, it is Dave who is liable to pay the IHT.
This tax can sometimes be reduced by taper relief depending on the amount of years the donor survives following the gift. It is commonly believed that tapering relief always applies in an estate if a gift is made and the person making the gift does not survive seven years. However, it is important to bear in mind that it only applies to reduce the tax if the failed PET exceeds the NRB. It is therefore fairly rare that taper relief will actually apply in an estate.
- •Using the same facts as the example above, if I had survived 6 years from the gift the actual tax payable would be reduced by 80% and so effectively 8% of the tax payable, so IHT of £6000 for Dave to pay (£75,000 @ 8%).
- •But if I give Dave £325,000 (having not made any earlier gifts) and I die six years later with an estate of £75,000, Dave will have no tax to pay (because the gift is within the NRB) but my estate will pay IHT of £30,000 (£75,000 @ 40%). There is no tapering to reduce the IHT in the estate.