The Inheritance Tax Act 1984 (IHTA 1984) governs the taxation of lifetime gifting. Section 3A of the IHTA 1984 defines a Potentially Exempt Transfer (PET) as a transfer of value made by an individual on or after 22 March 2006 that constitutes a gift to another individual, a disabled trust, or a bereaved minor’s trust.
To qualify as a PET, the disposition must result in a drop in the transferor’s estate value, and must not be treated as a deemed transfer of value under other provisions. If a transfer is entirely covered by a statutory exemption, it is an exempt transfer from the outset, rather than a PET.
“A potentially exempt transfer which is made seven years or more before the death of the transferor is an exempt transfer and any other potentially exempt transfer is a chargeable transfer.”
The 7-Year Rule and Taper Relief
The core mechanism of a PET is the 7-year rule. The law assumes the transfer will be exempt during the period beginning on the date of the gift and ending immediately before the seventh anniversary or the transferor’s death.
If the transferor dies within seven years of making the gift, the PET fails and becomes a chargeable transfer. However, section 7(4) of the IHTA 1984 provides taper relief, which reduces the amount of inheritance tax payable on the failed PET, provided the transferor survives the gift by at least three years.
Table: Taper Relief Rates (IHTA 1984, s 7(4))
| Years between gift and death | Percentage of standard death rate payable | Effective Tax Rate (assuming 40% standard rate) |
|---|---|---|
| 0 to 3 years | 100% | 40% |
| 3 to 4 years | 80% | 32% |
| 4 to 5 years | 60% | 24% |
| 5 to 6 years | 40% | 16% |
| 6 to 7 years | 20% | 8% |
| More than 7 years | 0% (Fully Exempt) | 0% |
The relief applies strictly to the tax charged on the value transferred, rather than reducing the value of the gift itself. This means the full value of the PET still consumes the deceased’s nil-rate band before taper relief reduces the tax on the excess.
Thresholds and 2026/27 Updates
For the 2026/27 tax year, the core inheritance tax thresholds remain frozen. Legislation fixes the nil-rate band (NRB) at £325,000 and the residence nil-rate band (RNRB) at £175,000 until April 2028.
Crucially, practitioners must account for the April 2026 reforms to Agricultural Property Relief (APR) and Business Property Relief (BPR). From April 2026, APR and BPR are restricted to a 100% relief rate on the first £1 million of value (or £2.5 million combined in specific contexts), with any excess value only receiving 50% relief. This reform directly affects the “value transferred” calculations when a client makes a PET involving agricultural or business assets, as a failed PET will no longer benefit from uncapped 100% relief.
Interaction with Lifetime Exemptions
A transfer of value is not a PET to the extent that it qualifies for statutory lifetime exemptions. Clients can utilise the following provisions to make immediately exempt transfers:
- Annual Exemption: Section 19 allows an individual to gift up to £3,000 per tax year completely free of IHT. Unused annual exemption can carry forward for one year only.
- Small Gifts: Section 20 exempts outright gifts to any one person up to £250 per tax year.
- Normal Expenditure out of Income: Section 21 exempts gifts made as part of normal expenditure, provided they are made out of surplus income and leave the transferor with sufficient income to maintain their usual standard of living.
- Family Maintenance: Section 11 completely removes dispositions for the maintenance of a spouse, civil partner, or dependent child (until 18 or the end of full-time education) from the definition of a transfer of value.
Gifts with Reservation of Benefit (GWR)
When advising on PETs, you must ensure the transferor does not retain a benefit in the gifted property. If the transferor continues to enjoy the property, section 102 of the Finance Act 1986 treats it as a Gift with Reservation of Benefit (GWR), keeping the property in the transferor’s estate for IHT purposes.
If the reservation ceases during the transferor’s lifetime, the legislation treats the transferor as making a “deemed PET” on the exact date the reservation ends. The seven-year clock for this deemed PET only starts ticking from the date the reservation ceases, and the annual £3,000 exemption is not available against a deemed PET.
Next steps for research: Consider reviewing the specific anti-avoidance provisions relating to pre-owned assets tax (POAT) to ensure alternative charging provisions do not apply where a PET or GWR fails. Furthermore, assess how the April 2026 APR/BPR cap interacts with lifetime trusts compared to outright PETs.
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