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IHT shouldn&#39t happen to a Pet

The concept of a potentially exempt transfer was introduced in 1986 at the same time as inheritance tax replaced capital transfer tax.

A Pet is a transfer of value that will not trigger an inheritance tax charge if certain criteria are met.

The first criteria for being a Pet is that the transfer of value must be a gift. But when is a transfer of value a gift?

The Inheritance Tax Act says a transfer of value is only a gift to the extent that, by reason of the transfer, the estate of another person is increased. There are many situations where the transfer of value is not the same as the sum gifted (see table right).

Is this a problem? In 95 per cent of cases, it is not a problem, particularly with regular-premium life policies as most premiums will be exempt under the annual or normal expenditure out of income exemption.

So when is a gift a Pet? Some gifts are Pets while others are chargeable at the time they are made (see table left).

What is the most fundamental difference between a Pet and a chargeable transfer? No lifetime charge will occur as a result of a Pet whereas a lifetime charge can occur in respect of a chargeable transfer. Provided the donor survives for seven years from the date of the Pet, no inheritance tax will be paid on that gift.

A lifetime charge could arise where the cumulative total of all chargeable transfers within the last seven years comes to more than the nil-rate band, currently £234,000.

However, few chargeable transfers are made nowadays. For most people, the only chargeable transfers they make will be the chargeable element to any premium paid to a policy held in trust. With a nil-rate band of £234,000, the chargeable element would have to be more than £33,470 (£234,000 divided by seven) before the seven-year cumulative total exceeded £234,000.

We can also probably expect the Chancellor of the Exchequer to increase the nil-rate band in future Budgets over the years.

All in all, a lifetime charge is unlikely to arise in respect of premiums paid to a life policy in trust.

Do you want to make sure that premiums are Pets? Yes, so set up a trustee bank account, pay the premium into this account and the trustees complete a direct debit on that account to pay the premium. That way, the sum paid into the trustee bank account will be a Pet.

Most gifts now are Pets. However, you need to make sure they are not caught by the gift-with-reserva-tion rules.

A gift with reservation is one where the donee does not assume full possession and enjoyment of the gift or the property is not enjoyed to the entire exclusion or virtually the entire exclusion of the donor.

Basically, a gift will not be effective for inheritance tax purposes if you give something away but keep some benefit for yourself.

If a gift is reckoned to be one with reservation, the asset will remain in the donor&#39s estate. No inheritance tax will be payable at that time but the est-ate will possibly be bigger than expected when the donor dies.

It is essential that we recognise or take advice on gifts that may be gifts with reservation so that the potential inheritance tax liability on death can be estimated accurately.


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