Techzone

IHT on lifetime transfers

An individual who makes a gift during their lifetime may be treated for IHT purposes as making:

• an exempt transfer or
• a potentially exempt transfer (PET) or
• a chargeable lifetime transfer (CLT)

It is possible for a single gift to be part exempt and part PET or CLT. For example, a gift into a discretionary trust could be partially covered by the £3,000 annual exemption with the excess being a CLT.

It is not only gifts which may be transfers of value for IHT.  There may also be a transfer of value if something is sold for less than its market value. For example, selling a holiday home to a son or daughter at half its true value will mean there is also a transfer of value for IHT for the other half.

Exempt transfers

Certain lifetime transfers are immediately exempt for IHT. The main such exemptions are:

• gifts between UK domiciled spouses and civil partners
• gifts to charities and political parties
• gifts for national benefit, such as to museums, universities, libraries or the National Trust
• gifts up to £3,000 each tax year
• gifts of up to £250 to any number of people in the same tax year
• regular gifts out of surplus income (normal expenditure out of income)
• gifts in consideration of marriage or civil partnership. The exempt amount is £5,000 per parent, £2,500 for grandparents and £1,000 for anyone else

For further details on IHT exemptions please read our Technical Guide on IHT exemptions and reliefs.

Potentially exempt transfers (PETs)

A potentially exempt transfer (PET) will arise where an individual makes a gift:

• to an individual or
• to an absolute/bare trust or
• to a disabled trust or
• to an interest in possession trust or accumulation and maintenance (A&M) trust if the gift was made before 22 March 2006

A PET will only become chargeable to IHT where the donor fails to survive for seven years from the date of gift. In this event, the value of the failed PET is added to the donor's estate along with any other gifts made by the donor in the seven years prior to death.

Chargeable lifetime transfers (CLTs)

A chargeable lifetime transfer (CLT) will arise where an individual makes a gift into a relevant property trust. Previously only a gift into discretionary trust would have been a CLT but from 22 March 2006 this regime was extended to many more trusts including most new interest in possession trusts.

A CLT will be subject to an immediate charge to IHT at 20% where the value of the CLT, when added to any other CLTs made by the settlor in the preceding seven years, exceeds the IHT nil rate band (that is the main nil rate band not including any transferable or residential nil rate band).

The liability to IHT on the CLT rests with the settlor, although the settlor and trustees can agree between them as to who pays. The amount of the transfer must be grossed up if the settlor pays the tax.

If the donor survives for seven years from the date of gift there will be no further IHT payable but there is no refund of any IHT paid at outset.

IHT on gifts within seven years of death

On death any chargeable transfers (both CLTs and any failed PETs) made in the preceding seven years will be added back into the estate.

IHT is only payable if the total transfer is greater than the available nil rate band including any transferable nil rate band (but not including the residential nil rate band).  Where there have been multiple gifts they will use the nil rate band in chronological order with the earliest transfer having first use of the nil rate band.

While there is no further IHT on chargeable transfers which fall within the nil rate band it will mean there is less nil rate band available to use against the deceased’s estate. This will mean that IHT may become payable at 40% on other assets within the estate.

If chargeable transfers exceed the available nil rate band at death then IHT may be chargeable at 40% on the excess. Any lifetime tax at 20% paid on chargeable lifetime transfers is available as a credit against the recalculated IHT liability.

Where the donor dies between three and seven years from the date of the gift, any IHT which becomes payable can be reduced by taper relief. Taper relief reduces the amount of tax payable not the value of the transfer. Relief is given at 20% increments for each year from year three onwards.  Any IHT paid at outset can be offset against the IHT payable on death. But it is not possible to reclaim any tax where the IHT paid at outset exceeds the tax due on death as a result of  taper relief or an increased nil rate band at the date of death.

Any tax on gifts in the years before death is the responsibility of the recipient. In the case of gifts to trusts the liability rests with the trustees.

Gifts with reservation

A gift with reservation (GWR) occurs where the donor continues to have the ability to enjoy any form of benefit from the gifted asset. In these circumstances the gifted property will remain part of the donor's estate for IHT purposes. The legislation applies to gifts made on, or varied after, 18 March 1986.

Relief against double IHT charge on gifts with reservation

There is a possibility of two IHT charges on the death of the donor who has made a gift with reservation of benefit. The transferred property remains in the donor's taxable estate and so is subject to IHT. In addition, the lifetime transfer is chargeable if death occurs within seven years. However, there is a double charging relief that ensures there is only one charge to IHT. Whichever of the two amounts produces the higher tax liability is the amount chargeable.

Ending a gift with reservation

Sometimes, a donor may decide to give up the interest that they have retained on a previous gift and when they do this, the gift with reservation is no longer included in their estate for IHT purposes. However, when the interest is given up a potentially exempt transfer (PET) will be made and so IHT may still be payable on death.

Associated operations

A series of transactions may be treated as an associated operation for IHT where they affect the same property or form a chain of linked transactions. These do not need to be done at the same time or by the same person.

By treating the transactions as associated operations it is possible for HMRC to look at the overall effect of the various events rather than looking at each transaction in isolation.

Where the transactions involve a gift and the donor continues to obtain a benefit through an associated operation, this will result in a gift with reservation.

Pre-owned asset tax (POAT)

Pre-owned asset tax (POAT) imposes an annual income tax charge on schemes that are designed to avoid the gift with reservation rules.

How the charge is calculated depends upon the type of asset.

• For land and property the income tax charge will be based upon the rental value of the property
• For intangible assets, such as investment bonds, the chargeable amount is the market value of the asset multiplied by HMRCs prescribed interest rate of 4%.  This will increase to 4.25% from 22 August 2023.

In general, arrangements that are subject to the IHT GWR rules (and therefore ineffective in IHT mitigation) are excluded from the POAT charge. This ensures there is no double tax charge in respect of the same asset.

Where the POAT charge applies in respect of an asset, there is an option to elect that the arrangement is treated as a gift with reservation instead. This might be done for a number of reasons, such as:

• the arrangement wasn't designed to save IHT, and treating the arrangement as a gift with reservation won't result in an IHT charge or
• the arrangement is difficult or impossible to unwind, and the income tax charge would create hardship not anticipated when it was effected

The deadline for such an election is normally 31 January following the end of the tax year in which a chargeable benefit first arises.

Business property relief

Lifetime transfers of business property may qualify for business property relief (BPR) at 100% or 50%.

The main conditions are:

• The business property must have been owned by the transferor for at least two years (if the business assets were inherited from a spouse or civil partner it will be their combined period of ownership)
• The business must be trading and not investment
• 100% relief is available for
  
  
  • a business or interest in a business (includes sole traders and partnerships)
  • a holding of shares in an unquoted company (including AIM companies)
• 50% relief applies to
  
  
  • controlling holding of shares in a quoted company (more than 50% of the voting rights)
  • land or buildings, machinery or plant used wholly or mainly for the purposes of the business carried on by a company or partnership
• excepted assets such as investments or excessive levels of cash will not benefit from BPR

BPR can be withdrawn if the donor dies within seven years of a lifetime gift of business property and the recipient no longer owns it and has not reinvested the proceeds in a replacement asset or the asset no longer qualifies for BPR, for example, an unquoted company becomes listed on the Stock Exchange.

Agricultural property relief

Lifetime transfers of agricultural property such as farmland, farm buildings, farmhouses and farm cottages may qualify for agricultural property relief (APR) at 100% or 50%.

The main conditions for 100% relief are:

• the agricultural property must have been owned and farmed by the transferor for at least two years or
• owned for seven years if it's let out to someone else for agricultural purposes

Relief is limited to 50% if the land was let prior to 1 September 1995 and the owner does not have the right to vacant possession within 24 months.