Potentially exempt transfers and gifts with reservation

When you carry out succession planning, one of the key elements is to consider whether to gift part of your wealth now or wait until your death. If you decide to gift assets whilst you are alive, certain rules apply for Inheritance Tax (IHT) purposes. Key to understanding whether the gift you make will be exempt from IHT is to understand the rules surrounding “potentially exempt transfers” and “gifts with reservation”.

The main thrust of lifetime gifting is to reduce the amount of your taxable estate at the time of your death. If you successfully do this you will limit the exposure of your estate to IHT and maximise the value transferred to your successors.

What is a potentially exempt transfer (PET)?

As defined by HMRC, a potentially exempt transfer is a lifetime transfer of value that satisfies three conditions:

• the transfer is by an individual made on or after 18 March 1986;
• it would be a chargeable transfer apart from Section 3A of the Inheritance Tax Act 1984 (or, if only partly chargeable, is a potentially exempt transfer to the extent that it would be chargeable); and
• it is a gift to another individual or to a specified trust.

This means you need to transfer an asset of value to another individual or a specified trust where, importantly, the transfer would be chargeable to IHT. Transfers between spouses or civil partners and gifts to charity cannot be potentially exempt transfers because these are all not chargeable to IHT.

A common example of a potentially exempt transfer is where you transfer ownership of a property to your children. If you transfer a property you own to your children, it will be classed as a potentially exempt transfer.

Provided you survive for seven years, the value of any potentially exempt transfer will be removed from your estate and will not be subject to IHT. However, if you die within the seven-year period, you may still receive a reduction in the value on which you pay IHT.

What are gifts with reservation (GWR)?

A criticial element of potentially exempt transfers is that you totally divest yourself from the gift. If you fail to do that, it might be considered a gift with reservation.

Perhaps the easiest way to explain this is to look at the transfer of a property to your children. If the property you transfer is the family home and you continue living in it, it is very likely to be considered as a gift with reservation unless:

• You pay a market rent for the property; and
• Pay your share of maintenance and repair costs.

If you fail to comply with these conditions, the transfer will generally be considered a gift with reservation and the value of the property at the date of death will be deemed to remain part of your estate and chargeable to IHT.

How are these viewed from an IHT perspective

The reasons for the rules surrounding potentially exempt transfers and gifts with reservation was that HMRC considered it “unsatisfactory if the transferor continued to receive benefit from the gifted property”. A blunter interpretation might be that you cannot have your cake and eat it too.

There are clearly defined rules surrounding gifting your wealth to reduce your exposure to IHT. Complying with these rules can, on occasions, be challenging.
That is why it is essential to obtain expert professional advice.

Estate and Inheritance Tax Planning Solicitors, Edinburgh

If you would like to discuss any of the issues covered in this article, or if you require assistance with any other matter, please contact us  or call us on 0131 225 1200.

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