Those of a certain vintage will remember ‘Auf Wiedersehen, Pet’, a comedy series from the 1980s. Of course, a PET (potentially exempt transfer) in an inheritance tax (IHT) context has a different meaning. However, the comedy title has a certain relevance in one sense – individuals who make lifetime gifts can say ‘goodbye’ to a PET for IHT purposes after a set period.
What is a PET?
A PET is a lifetime gift that satisfies three conditions: it is made by an individual (on or after 18 March 1986); it would otherwise be a chargeable transfer; and it is broadly a gift to another individual or certain categories of trust. A PET is assumed to be an exempt gift when made, so no immediate IHT liability arises (unlike, say, a gift into a discretionary trust, which is immediately chargeable). If the donor survives for seven years or more thereafter, the gift becomes actually (i.e., no longer potentially) exempt.
Not a PET
Certain types of gift cannot qualify as PETs, in addition to gifts into most types of trust (see above). These include gifts to a company (i.e., because the recipient is not an individual), and deemed dispositions on alterations in the capital or share rights of close (i.e., broadly closely controlled) companies. However, the remainder of this article focuses on gifts to individuals.
Does it Qualify?
A gift to another individual is capable of qualifying as a PET to the extent that it satisfies one of two alternative conditions. The first condition is that the value of the gift becomes comprised in the estate of the recipient individual. For example, if a parent transfers £100,000 to their daughter’s bank account, the value of the gift becomes comprised in the daughter’s estate. By contrast, if a grandparent directly pays the private school fees of a grandson, that is not a PET because the gift does not become comprised in the grandson’s estate (however, the grandparent could instead consider making a cash gift to the grandson’s parents to enable their son’s school fees to be paid). The alternative condition for PET treatment applies to the extent that the transfer results in the other individual’s estate being increased.
Example: I ‘Forgive’ You…
Eric lent his best friend Ernie £250,000 nearly five years ago, as Ernie was going through a messy divorce. Eric now decides that he does not need the money to be repaid and forgives Ernie’s debt. This does not satisfy the first condition for PET treatment, as the forgiveness of the debt does not become comprised in Ernie’s estate. However, the alternative condition for PET treatment is satisfied, as Ernie’s estate is increased due to no longer owing money to Eric. The PET rules refer to a ‘transfer of value’ as opposed to a ‘gift’, so the scope of the rules is seemingly wider. For example, if parents sell a house worth £500,000 to their son for £100,000, the transaction is strictly a sale rather than a gift, but the son’s estate is increased by the transfer of value so it qualifies as a PET by the parents.
Practical Tip
As a PET is assumed to be exempt when made, there is no immediate need to inform HM Revenue and Customs. However, records of all gifts and transfers should be kept, in case the donor dies within seven years.
