Do some PETS bite? (Part 2)

In my previous blog ( 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 important factor in this type of trust is that the life tenant has the right to the trust income. This means that if the trust generates £1000 interest a year this would belong to the life tenant. Or if the asset is a house the life tenant would have the right to occupy it.

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.

·         For example, if I am the life tenant of a trust created pre 22 March 2006 which gives me the right to benefit from a house until I marry, when I marry and my ‘life interest’ comes to an end I am deemed to have made a PET of the value of the house (despite the fact that I have no control over who will become the owner of the house).

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).

·         So for example, using the facts above, if the property I have a ‘life interest’ in is worth £325,000 and my life interest come to an end because I marry, I am treated as having made a gift of £325,000. If I then make a gift of £100,000 but die within a year the recipient of the £100,000 would pay IHT of £40,000 (NRB is zero because the life interest ending uses it up so then £100,000 @ 40%).

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!

If you have any questions regarding IHT and PET’s, wills, trusts or probate matters or would like to make or amend a will then please contact Mark Shaw on 01756 692 866or email
Mark Shaw
Wills, Trusts & Probate
Tel: 01756 692 886