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

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.
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.

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

Suggested Books for Further Studies

“Personal Tax Planning: Principles and Practice” by Malcolm Finney
- This book provides a comprehensive overview of personal tax planning including inheritance tax and PETs.
“Practical Inheritance Tax Planning” by Mark McLaughlin
- A practical guide detailing various strategies around IHT including potentially exempt transfers.
“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

### What must occur for a Potentially Exempt Transfer (PET) to be exempt from inheritance tax? - [ ] The asset must appreciate in value. - [ ] It must be a gift to a spouse. - [x] The donor must survive for seven years after making the gift. - [ ] The donor must declare it on the will. > **Explanation:** For a PET to be exempt from inheritance tax, the donor needs to survive for seven years after making the gift. If the donor dies within this period, the gift might be counted back into the estate for IHT evaluation. ### If the donor of a PET dies four years after the gift was made, which tax relief might apply? - [ ] Immediate relief - [ ] Full exemption - [x] Graduated relief - [ ] Standard charge > **Explanation:** Graduated relief applies to PETs if the donor dies between three and seven years after making the gift, reducing the amount of IHT payable. ### What is the current nil-rate band for inheritance tax purposes (as of 2016-17)? - [ ] £200,000 - [x] £325,000 - [ ] £350,000 - [ ] £275,000 > **Explanation:** The nil-rate band for inheritance tax purposes as of the 2016-17 tax year is £325,000. Gifts up to this amount may not incur IHT. ### What happens to a PET if the donor survives the transfer by seven years? - [x] It becomes fully exempt from inheritance tax. - [ ] It becomes retrospectively taxed. - [ ] It is included in the property's estate value. - [ ] It is subject to capital gains tax. > **Explanation:** If the donor survives for seven years from the date of the gift, the PET becomes fully exempt from inheritance tax. ### When calculating inheritance tax liability, in which order are lifetime gifts reviewed upon the donor's death? - [ ] In reverse chronological order - [ ] Based on value size - [x] Chronological order - [ ] Random order > **Explanation:** The lifetime gifts are reviewed in chronological order for inheritance tax purposes to determine liability. ### When does an immediate charge arise for a Potentially Exempt Transfer (PET)? - [ ] When the gift exceeds £10,000 - [ ] When given to a person outside the donor's family - [x] There is no immediate charge - [ ] When the donor's wealth is over a million > **Explanation:** A Potentially Exempt Transfer (PET) does not incur an immediate inheritance tax charge. The seven-year survival rule is key. ### For a gift given five years before the donor's death, inheritance tax relief is most likely: - [ ] Not applicable - [ ] Flat 10% - [x] Graduated relief - [ ] Full exemption > **Explanation:** Graduated relief applies to gifts made between three to seven years before the donor's death, reducing the importible tax on such gifts. ### How does a PET differ from an immediately chargeable transfer? - [x] PETs only become taxable if the donor dies within seven years. - [ ] PETs are only applicable to cash gifts. - [ ] PETs immediately incur an inheritance tax. - [ ] PETs are only for transfers to spouses. > **Explanation:** PETs differ in that they only become taxable if the donor dies within seven years of making the gift, unlike immediately chargeable transfers. ### Which of the following is true about graduated relief? - [ ] It increases the tax liability. - [x] It reduces the tax liability for gifts made between three and seven years before death. - [ ] It applies to all gifts, regardless of timeframe. - [ ] It's a tax benefit given to property only. > **Explanation:** Graduated relief reduces the inheritance tax liability for gifts made between three and seven years before the donor's death. ### When does the nil-rate band get applied to PETs? - [ ] It is never applied. - [ ] Only if the gift is to a charity. - [ ] When the total gifts exceed £500,000. - [x] When reviewing gifts made within seven years of the donor's death. > **Explanation:** The nil-rate band is applied when reviewing the total amount of gifts made within seven years of the donor's death for PET evaluation.

Thank you for deepening your understanding of Potential Exempt Transfers and testing your knowledge with our quiz!