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Inheritance Tax: Chargeable Lifetime Transfers & Potentially Exempt Transfers
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See the Articles & Advice section for a wealth of information on tax planning.Chargeable Lifetime Transfers
Since the changes in legislation from 22nd March 2006 any lifetime transfers to:
- A company (a rare occurrence) OR
- Any trust (other than a disabled trust, bare trust or charitable trust)
will be chargeable lifetime transfers, thus rendering them subject to tax immediately in some cases. An example of such a chargeable lifetime transfer is payments of insurance premiums. These represent transfers of value into a trust (though there are other exemptions available with regards to these).
Chargeable transfers of value may be subject to the immediate payment of inheritance tax depending on the overall value of such transfers made by the transferor (person giving the gift) within the last seven years.
The amount of the chargeable transfer is derived at by deducting any available exemptions (see Inheritance Tax) from the 'transfer of value'. The amount of inheritance tax due is calculated according to the following formula:
Other chargeable transfers made within the past 7 years PLUS
The current chargeable transfer LESS
The nil rate band EQUALS:
The amount on which inheritance tax is now chargeable at 20% (half the death rate).
Example
This example ignores exemptions and reliefs apart from the nil rate band exemption of £285,000.
Three years ago Max paid £60,000 worth of investments into a discretionary trust, thus giving rise to a Chargeable transfer. However, no IHT was due as the sum was within the nil rate band.
Max now gives one of his properties worth £340,000 to the discretionary trust. He directs that the discretionary trust pay any inheritance tax due.
The trust will have to pay the tax as follows:
Other chargeable transfers within the past seven years | £60,000 |
ADD | |
THIS chargeable transfer | £340,000 |
| EQUALS: | |
Overall/cumulative chargeable transfers | £400,000 |
| LESS | |
The Nil Rate Band allowance | £285,000 |
| EQUALS: | |
| The amount on which Inheritance tax is now chargeable | £115,000 x 20% |
| Inheritance Tax immediately Due | £23,000 |
Grossing Up
In the above example, the tax has been paid by the transferee (the trust) as there was specific directions made by Max to this effect. Where no direction or instruction is made to the contrary, it is automatically assumed that the transferor pays the inheritance tax, and in these circumstances the amount due will be more as the principles of 'Grossing Up' are applied.
Grossing up is the principle that anyone who makes a gift is also making a gift of the tax which means that an additional 1/4 will need to be added to the value of the gift. With reference to the above example, if Max had paid the inheritance tax himself, it would have been subject to the grossing up principles as illustrated below:
Example
Amount chargeable as before | £115,000 |
Grossing Up factor of 1/4 | £28,750 |
Grossed Up amount | £143,750 |
Inheritance tax payable lifetime rate 20% | £28,750 |
As the above examples demonstrate, more tax is usually payable where the transferor settles the liability himself and as mentioned above, the transferor of a gift is ALWAYS assumed to be responsible for the liability unless there is evidence to the contrary. A way to avoid this is to draw up a memorandum of the gift stipulating that the transferee is to be responsible for any tax liability (these can be downloaded from the Brochure page).
Lifetime Chargeable transfers can be further reduced by applying Tapering Relief (see below).
Potentially Exempt Transfers (PETS)
Any gift over the exempt amount can be given to a person by way of direct gift or investment, and provided the donor (person who gave the gift) survives for 7 years after the date of the gift no inheritance tax will be due. During the seven year period, the inheritance tax that is potentially chargeable on the gift gradually reduces year by year until after the seventh year it is extinguished altogether thus no tax is incurred upon it.
Following new legislation from 22nd March 2006 only transfers by an individual to:
- Another individual
- A Bare Trust
- A Disabled Trust
will be potentially exempt. In addition, the transfer must satisfy the following:
- There must be an increase in the value of the transferee's estate (person to whom transfer/PET is made)
- Where the transferee is a disabled trust there must be an actual gift of property into the trust.
A PET which fails to satisfy the above conditions will be considered to be a chargeable lifetime transfer unless some other exemption can be applied.
Once a transferor dies both lifetime chargeable transfers and potentially exempt transfers made 7 years prior to the transferor's death are brought back into the estate of the deceased for inheritance tax purposes. This applies whether or not inheritance tax was payable at the time of the transfer.
Inheritance tax becomes payable at the full death rate of 40% on any transfers within the 7 year period (although if tax has already been paid on a transfer this can be deducted). Any additional inheritance tax which may be due is usually the responsibility of the transferees. Again, the best way to avoid the transferees bearing any tax is to record your intention to have the tax paid from your estate in a written Memorandum.
Further reductions can be made to the amount o f tax due by applying 'Tapering Relief'. An alternative option is to include a provision in your Will to the effect that any inheritance tax should be paid from your estate.
There are two problems with the above approaches:
- The payment of inheritance tax arising at the time of your death from your estate will be subject to the 'Grossing Up' rules at the full death rate of 40%
- If there are insufficient funds in your estate to cover the payment of the tax the transferee will still be responsible for paying it.
Fortunately, there is some relief available in the form of 'Tapering Relief'. This reduces the amount of tax payable if the transferor survives at least 3 years. If he or she survives the full 7 years after giving the gift, the transfer is completely exempt. The following table illustrates how this principle works.
| No. Years Before Death | % IHT Tax reduction i.e. tapering relief |
| 0-3 years | Nil full 40% tax applies |
| 3-4 years | 20% |
| 4-5 years | 60% |
| 5-6 years | 80% |
| 7 years + | No tax - entirely exempt |
Lifetime Chargeable Transfers & Tapering Relief
The above Tapering Relief can also be applied to Lifetime chargeable transfers. The tapering provisions could result in the tax liability on death being less than the amount already paid. Unfortunately, no refund is made and it simply means that no further tax is due.
When calculating the tax due on each chargeable transfer made within the 7 year period prior to death, every chargeable transfer in the seven years before THAT transfer must be taken into account. Thus, lifetime chargeable transfers made 14 years prior to death may still have an impact on the inheritance due on the transferor's estate.
It is advisable when making such transfers that full written details are set down, stating the date the gift was made, the amount or nature of the gift, to whom it was made and signed and retained with the Will (if there is one). You can download free PET Memorandum documents from the Brochure page.
It is essential when making your will that you provide the will drafter with as much information as you can in order to plan your will in a tax efficient way.
Inheritance Tax and estate planning can incorporate many of the above methods and tax exemptions. Another useful method is that of Life Insurance policies. For more details, and to carry out an online inheritance tax calculation, go to Inheritance Tax Calculator.
