Terminology explained

Potentially Exempt Transfers (PETs)

A Potentially Exempt Transfer allows for unlimited value gifts that become exempt from IHT if the donor survives for seven years after the gift. If the donor does not survive this period, the gift reduces the donor's available NRB.

'Clawback'

Clawback refers to the process by which the tax authorities reclaim Inheritance Tax (IHT) benefits previously granted on gifts or transfers if certain conditions are not met. For example, if a Potentially Exempt Transfer (PET) is made, but the donor does not survive for the required seven years, IHT benefits initially anticipated for that gift can be "clawed back" and become subject to taxation. This mechanism ensures that the tax advantages of certain estate planning strategies are only realised if all statutory conditions are fully satisfied over the specified time frames.

Scenario background

David

Simon

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David and Simon are civil partners.

They each own £200k of assets which potentially qualify for Business Relief (BR).

Simon acquired his BR assets two years ago, whilst David acquired his BR assets a year later.

They have now decided that they no longer need the BR assets, and so intend to gift their BR assets to their two children.

They are not concerned about the BR status of the gift as they are both in good health, and expect to comfortably survive seven years from the date of making the gift.

David and Simon died just months after gifting the BR assets to their children.

Scenario 1

• David had held the BR assets for just 1 year before gifting them to his children.

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David's Inheritance Tax (IHT) position (at the point of gifting the asset)

Asset:

£200k Assets

Tax Payable:

Nil

Neither David nor his children are liable to any immediate IHT on the gift of assets. Instead, the gift is treated as a PET and will be fully exempt from IHT provided David survives seven years from the date of making the gift.

The gift does not meet the qualifying criteria for BR due to David only having held the assets for one year.

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David's Inheritance Tax (IHT) position (upon death)

Asset:

£200k Assets

Tax Payable:

£80,000

David’s gift is regarded as a failed PET, therefore is liable to IHT at the full rate due to him dying within three years of the gift.

At the time of the transfer David did not qualify for BR, therefore does not receive any relief for the transfer.

Scenario 2

• Simon had held the BR assets for over two years at the time of gifting them to his children.

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Simon's Inheritance Tax (IHT) position (at the point of gifting the asset)

Asset:

£200k Assets

Tax Payable:

Nil

Neither Simon, nor his children, are liable to any immediate IHT on the gift of assets. Instead, the gift is treated as a PET and will be fully exempt from IHT provided Simon survives seven years from the date of making the gift.

Notwithstanding this, the gifted assets would satisfy the qualifying conditions for BR.

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Simon's Inheritance Tax (IHT) position (upon death)

Asset:

£200k BR Assets

Tax Payable:

Nil

Simon’s gift is regarded as a failed PET, therefore is liable to IHT at the full rate due to him dying within three years of the gift.

However, at the time of the transfer, Simon qualified for BR and as his children have continued to hold the BR assets. Full BR will apply to the gift on Simon’s death. If his children had not continued to hold the BR assets until Simon’s death, no BR would be available.

Take away

Simon and David gifted BR assets after having held them for just one and two years respectively.

If these BR assets were qualifying EIS or SEIS investments, the gift may have triggered the ‘clawback’ of any income tax relief received on the investment, and potentially be liable to Capital Gains Tax (CGT). Had they retained ownership, any “clawback” may not have arisen and would not have prejudiced the treatment upon death.

Careful timing of lifetime gifts is therefore required to ensure all relevant tax implications are considered.

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Opinions expressed represent the views of the author at the time of publication, are subject to change, and should not be interpreted as investment or tax advice.

Important notice: This article is for investment professionals only. This article is for information only and does not form part of a direct offer or invitation to purchase, subscribe for or dispose of securities and no reliance should be placed on it. No reliance should be made on this content to inform any investment of tax planning decision.

This content contains information that is believed to be accurate at the time of publication but is subject to change without notice. The explanation of all of the tax rules set out have been written in accordance with our understanding of the law and interpretation of it at the time of publication.

Whilst care has been taken in compiling this content, no representation or warranty, express or implied, is made by Downing LLP as to its accuracy or completeness, including for external sources (which may have been used) which have not been verified.

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