A Potentially Exempt Transfer (PET) is a type of lifetime gift that can potentially be exempt from Inheritance Tax (IHT)
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What is a Potentially Exempt Transfer (PET)?

A Potentially Exempt Transfer (PET) is a type of lifetime gift that can potentially be exempt from Inheritance Tax (IHT), provided that the donor (the person making the gift) survives for at least seven years after making the gift. PETs are an essential part of IHT planning, allowing individuals to pass on wealth to their loved ones without incurring an immediate tax liability.

Key Features of a PET

What Makes a Gift a PET?

A gift qualifies as a Potentially Exempt Transfer (PET) if it meets the following three conditions:

  1. Made by an Individual: The gift must be made by an individual rather than a company or other entity.

  2. Would Otherwise Be a Chargeable Transfer: The gift must be of a type that would normally be subject to IHT if not treated as a PET.

  3. Gift to Another Individual or Qualifying Trust: The gift must be made to another individual or a specific type of trust (such as a bare trust or an interest-in-possession trust).

How PETs Work

  • When a PET is made, it is assumed to be exempt from IHT at the time of the gift.
  • If the donor survives for seven years after making the gift, the PET becomes fully exempt from IHT.
  • If the donor dies within seven years, the PET may become a chargeable transfer, and IHT may be due.
  • IHT is calculated on a sliding scale known as taper relief, which reduces the tax rate depending on how long the donor survived after making the gift.

Example:

John gives his son £100,000 in May 2025. This is treated as a PET:

  • If John survives until May 2032 (seven years), the gift is fully exempt from IHT.
  • If John dies in 2029 (four years later), the PET becomes chargeable, and IHT may be due.

Gifts That Do Not Qualify as PETs

Not all gifts qualify as PETs. The following types of gifts cannot be treated as PETs:

  • Gifts to Companies: PETs must be gifts to individuals, not entities.
  • Gifts into Most Types of Trusts: Except for bare trusts or interest-in-possession trusts, gifts into discretionary trusts are immediately chargeable.
  • Gifts Resulting from Changes in Share Rights: For example, transferring shares in a closely controlled company can trigger an immediate IHT charge.

Example: Gifts That Do Not Qualify

  • Sarah transfers £50,000 to a limited company she controls. This cannot be a PET because the recipient is not an individual.
  • Mark places £75,000 into a discretionary trust for his grandchildren. This is not a PET because discretionary trusts are not eligible.

Does Your Gift Qualify as a PET?

A gift can qualify as a PET if it meets one of the following conditions:

Condition 1: The Gift Becomes Part of the Recipient’s Estate

This means that the value of the gift is included in the recipient’s estate for IHT purposes.

Example:

  • A parent transfers £100,000 directly to their daughter’s bank account. This is a PET because the money becomes part of the daughter’s estate.
  • A grandparent pays private school fees directly to a school for their grandson. This is not a PET because the payment does not become part of the grandson’s estate. However, the grandparent could gift the money to the child’s parents, who could then pay the fees.

Condition 2: The Recipient’s Estate Increases as a Result of the Gift

Even if the gift does not directly enter the recipient’s estate, it can still be treated as a PET if it increases the recipient’s overall wealth.

Taper Relief: Reducing IHT on PETs

If the donor dies within seven years of making a PET, the gift may become chargeable to IHT. However, the amount of IHT payable can be reduced through Taper Relief, which works as follows:

Time Between Gift and Death IHT Rate Reduction
0-3 years No reduction
3-4 years 20% reduction
4-5 years 40% reduction
5-6 years 60% reduction
6-7 years 80% reduction

Example:

Jane makes a PET of £200,000 to her son. She dies five years later. The IHT due on the gift is reduced by 60% due to taper relief.

  • Initial IHT (at 40%): £200,000 × 40% = £80,000.
  • Taper Relief (60%): £80,000 × 60% = £48,000.
  • IHT payable: £80,000 – £48,000 = £32,000.

Keeping Records of PETs

Although there is no immediate need to inform HM Revenue and Customs (HMRC) when making a PET, it is essential to keep clear records of all gifts made. These records should include:

  • The date of the gift.
  • The value of the gift.
  • The recipient of the gift.
  • Any relevant documentation, such as bank statements or gift agreements.

These records will be critical in the event of the donor’s death within seven years, as they will help establish which gifts are subject to IHT.

Practical Tip:

Maintain a “Gift Register” with details of all lifetime gifts made. This will make it easier for your executors to complete your IHT return if necessary.

Why Are PETs an Important Part of IHT Planning?

PETs are a valuable tool in Inheritance Tax planning because they allow individuals to pass on wealth without an immediate tax charge. For families looking to reduce their IHT liability, making use of PETs can be an effective strategy.

Key Benefits of PETs:

  • No Immediate Tax Charge: PETs are treated as exempt at the time of the gift.
  • Seven-Year Rule: Gifts can become fully exempt if the donor survives for seven years.
  • Taper Relief: Even if the donor dies within seven years, taper relief can reduce the IHT payable.

Example: Using PETs for IHT Planning

  • Mr. and Mrs. Smith gift £150,000 each to their children in 2025. These gifts are PETs.
  • If they survive for seven years, the gifts are fully exempt from IHT.
  • If they die within seven years, the gifts become chargeable, but taper relief may reduce the tax.

Common Mistakes to Avoid with PETs

  1. Gifting to Companies or Trusts: PETs can only be made to individuals or specific qualifying trusts.

  2. Failing to Keep Records: Without clear records, it may be difficult to prove that a gift qualifies as a PET.

  3. Assuming All Gifts Are PETs: Not all lifetime gifts qualify as PETs, especially those involving trusts.

  4. Forgetting About the Seven-Year Rule: Always consider the impact of the donor’s survival on the IHT treatment of the gift.

Secure Your Estate with Merranti Accounting

Understanding and making the most of Potentially Exempt Transfers is a key part of effective Inheritance Tax planning. At Merranti Accounting, we help you:

  • Identify which gifts qualify as PETs.
  • Maintain accurate records of your lifetime gifts.
  • Structure your estate to minimize IHT.

Protect your family’s wealth with expert IHT planning from Merranti Accounting.

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