Transfer of value, Chargeable Transfer, Potentially Exempt Transfer

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What is a transfer of value?

It is the reduction in value of a person's estate because they made a gift

A gift made during a person’s lifetime may be either:

  1. Potentially exempt transfer (PET)

  2. Chargeable lifetime transfers (CLT)

1) Potentially exempt transfers

Any transfer that is made to another individual is a potentially exempt transfer (PET). 

If the donor survives for seven years then the PET becomes exempt and can be completely ignored

A PET only becomes chargeable if the donor dies within seven years of making the gift. 

So, remember:

  • If the donor dies within seven years of making a PET then it becomes chargeable.

  • Tax will be charged according to the rates and allowances applicable to the tax year in which the donor dies.

  • However, the value of a PET is fixed at the time that the gift is made.

Illustration:

Sophie died on 23 January 2024. 

She had made the following lifetime gifts:

  • 8 November 2016 – A gift of £450,000 to her son.

  • 12 August 2021 – A gift of a house valued at £610,000 to her daughter. 

    By 23 January 2024, the value of the house had increased to £655,000. Sophie did not live in the house after the gift.

Solution:

  • • The gift to Sophie’s son on 8 November 2016 is a PET for £450,000. 

    Because the PET was made more than seven years before the date of Sophie’s death it is exempt from IHT.

  • The gift to Sophie’s daughter on 12 August 2021 is a PET for £610,000 and is initially ignored. 

    It becomes chargeable as a result of Sophie dying within seven years of making the gift, and the transfer of £610,000 less annual exemptions of £3,000 pa for 2021/22 and 2020/21 will be charged to IHT based on the rates and allowances for 2023/24. 

    No taper relief will apply because Sophie dies within 3 years of making the gift.

2) Chargeable lifetime transfers

Any transfer that is made to a trust is a chargeable lifetime transfer (CLT).

  • There is no legal definition of what a trust is, but essentially a trust arises where a person transfers assets to people (the trustees) to hold for the benefit of other people (the beneficiaries). 

    For example, parents may not want to make an outright gift of assets to their young children. 

    Instead, assets can be put into a trust with the trust being controlled by trustees until the children are older.

  • Unlike a PET, a CLT is immediately charged to IHT based on the rates and allowances applicable to the tax year in which the CLT is made. 

    An additional tax liability may then arise if the donor dies within seven years of making the gift. 

    Just as for a PET, the value of a CLT is fixed at the time that the gift is made, but the additional tax liability is calculated using the rates and allowances applicable to the tax year in which the donor dies.

Illustration:

Lim died on 4 December 2023. 

She had made the following lifetime gifts:

  • 2 November 2016 – A gift of £420,000 to a trust.

  • 21 August 2021 – A gift of a house valued at £615,000 to a trust. By 4 December 2023, the value of the house had increased to £650,000.

Solution:

  • The gift to the trust on 2 November 2016 is a CLT for £420,000, and will be immediately charged to IHT based on the rates and allowances for 2016/17. 

    There will be no additional tax liability as the gift was made more than seven years before the date of Lim’s death.

  • The gift to the trust on 21 August 2021 is a CLT for £615,000, and will be immediately charged to IHT based on the rates and allowances for 2021/22. 

    Lim has died within seven years of making the gift so an additional tax liability may arise based on the rates and allowances for 2023/24.

Saving IHT

It is beneficial for a grandparent to give their grandchildren gifts to save IHT.

This is because if the grandparent gave it to their child and then their child gave it to their child - IHT would be paid 3 times as all 3 individuals would die, whereas if the grandparent gave the gift directly to their grandchild, IHT would only be paid twice as there would only be 2 death's involved for IHT - the gift never went to the third person.

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