Most gifts made during a person’s life are not subject to tax at the time of the gift. These lifetime transfers are known as 'potentially exempt transfers' or 'PETs'.  These gifts or transfers achieve their potential of becoming exempt if the taxpayer survives for more than seven years after making the gift. If the taxpayer dies within 3 years of making the gift, then the inheritance tax position is as if the gift was made on death. A tapered relief is available if death occurs between three and seven years after the gift is made.

PETs have encouraged many people to make gifts during their lifetime. Problems can arise if the donor does not want to give up control over the assets concerned. A common example is a person gifting their home but continuing to live in it rent-free. Such gifts are known as 'gifts with a reservation of benefit'. The taxman will not accept that a true gift has been made so the 'gift' remains subject to inheritance tax even if the taxpayer dies more than 7 years later.

The effective rates of tax on the excess over the nil rate band are:

• 0 to 3 years before death 40%
• 3 to 4 years before death 32%
• 4 to 5 years before death 24%
• 5 to 6 years before death 16%
• 6 to 7 years before death 8%

These tapered rates cannot reduce the tax due on a lifetime chargeable transfer below the amount chargeable when the transfer was made, and so are of no benefit to a transfer within the nil rate band.

Planning note

We would recommend that you keep a list of any PETs that you make. It is also important to keep a record of any exemptions that are used as well as details of any regular gifts made out of surplus income.