Potentially Exempt Transfer (PET)

Definition

A Potentially Exempt Transfer (PET) is a lifetime gift made by an individual which is considered for inheritance tax (IHT) purposes. PETs are not immediately liable to IHT upon transfer. The main condition for a PET to be exempt is that the donor must survive for seven years following the date of the gift. If the donor dies within this seven-year period, the gift may become part of the donor’s estate for IHT calculations with possible tax liabilities.

Key Points

• No Immediate Charge: There is no immediate inheritance tax charge when a PET is made.
• Seven-Year Rule: If the donor survives for seven years from the date of the gift, it becomes fully exempt from IHT.
• Tax Liability If Death Occurs Within Seven Years: If the donor dies within seven years, the transferred assets are counted back into the estate and evaluated for IHT based on the order of giving.
• Nil-Rate Band: Gifts are covered by the nil-rate band (0% tax rate) if they fall under a specified threshold (£325,000 for the tax year 2016-17).
• Graduated Relief: Gifts made between three and seven years before death may qualify for graduated relief, reducing the tax burden.

Examples

1. Mr. Smith Makes a Gift to His Daughter:

   • In 2016, Mr. Smith gifts his daughter £100,000.
   • He survives the next seven years; hence, this gift is exempt from IHT.

2. Mrs. Johnson Transfers Property to Her Son:

   • In 2010, Mrs. Johnson gives a property worth £350,000 to her son.
   • If she dies in 2014, her estate will undergo IHT calculations. The £325,000 nil-rate band would apply first, and then any excess would be subject to graduated relief or the standard rate.

Frequently Asked Questions

Q1: What qualifies as a Potentially Exempt Transfer (PET)?
A1: Any lifetime gift made by an individual that is not an exempt transfer for IHT purposes qualifies as a PET. The major condition is the survival of the donor for seven years post-transfer to be fully exempt from IHT.

Q2: How is Inheritance Tax calculated if the donor dies within seven years?
A2: If the donor passes away within seven years, the gifts within that time are reviewed. The first £325,000 worth of gifts, known as the nil-rate band, are not taxed. Any value above this involves tax calculations and may benefit from graduated relief between years three and seven.

Q3: Is there a scenario where a PET does not become chargeable upon the donor’s death within seven years?
A3: If the total lifetime gifts in the seven years preceding the death do not exceed the nil-rate band threshold, they remain untaxed. Any gifts beyond that threshold would have been subjected to tax.

Related Terms

• Inheritance Tax (IHT): A tax on the estate of the deceased, including money, property, and possessions.
• Chargeable Transfer: A transfer of assets upon which inheritance tax is payable because it isn’t exempt.
• Nil-Rate Band: The threshold below which the estate (or gifts) does not attract inheritance tax.
• Graduated Relief: A reduction in inheritance tax applicable to gifts made between three to seven years before the donor’s death.

Online References

1. GOV.UK: Inheritance Tax
2. HMRC: Inheritance Tax
3. STEP: The Seven-Year Rule

Suggested Books for Further Studies

1. “Personal Tax Planning: Principles and Practice” by Malcolm Finney

   • This book provides a comprehensive overview of personal tax planning including inheritance tax and PETs.

2. “Practical Inheritance Tax Planning” by Mark McLaughlin

   • A practical guide detailing various strategies around IHT including potentially exempt transfers.

3. “Tolleys Tax Planning for Individuals” by Helen Adams

   • An extensive text covering the key tax planning concepts, strategies including PETs.

Accounting Basics: Potentially Exempt Transfer Fundamentals Quiz

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