Inheritance tax – the importance of pets

First published on 13 May 2021 by Alastair
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Being tax specialists, one of the most common things we are asked about at M&S is inheritance tax. It’s a fairly complex subject and often misunderstood.  Today, I’m going to look at one aspect of it, namely the importance of PETS – potentially exempt transfers.

Here’s an example of what I mean…

Say someone has already gifted £325,000 in cash to a child or grandchild and then wants to pay an additional sum of £150,000 into a discretionary trust for them - does this mean that they will have to pay inheritance tax on the additional sum?

The first thing they need to know is that making a gift into a discretionary trust is regarded in law as what is known as a “chargeable lifetime transfer.”  Under the 1984 Inheritance Tax Act (IHTA), the inheritance tax nil rate band (NRB) is £325,000.  In plain language, no IHT is payable on that £325,000.  This means that in our example, you would assume that the person who wants to make the additional gift of £150,000 to a discretionary trust has already used up their nil rate band so they might expect to have to pay IHT on the £150K.

However, a gift of cash from one person to another is a potentially exempt transfer (PET) and is not taken into account for your NRB, UNLESS the donor does not live for another seven years after making this gift.  If he or she dies before this seven-year period is up, then this is what is known as a “failed PET” and tax is therefore payable on a sliding scale based on how long it is since the gift was given.

The way this works is as follows.  After allowing for the available annual exemption (these are £3,000 per annum) your available nil rate band would first be used against the failed PETs as the chargeable transfers are calculated in date order. Assuming you have not used the previous year annual exempt, you may have £6,000 of exemption, so the amount of IHT that would be paid would be based on £144K (£150,000 less £6,000).

This also assumes that there is only a single nil rate band available. Where there is a spousal/civil partner who has died previously, their NRB (or however much of the £325,000 is left after their estate is settled) can be linked to their partner/spouse’s NRB, thus increasing the amount of non-taxable money available.

However, if there is only a single NRB, then, as noted above, part or all of the transfer to the trust would become chargeable, depending on how much of the NRB has been used against the failed PETs.

I appreciate this can be fairly mind-boggling…  If you need advice on any aspect of tax, please don’t hesitate to get in touch.  M&S is a genuine tax specialist, one of the few in Fife with all the necessary qualifications to provide you with all the advice you need.

Vivian Linstrom, M&S Accountancy and Taxation


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