Sequence of Gifting

PETs enable an individual to make gifts of unlimited value which will become exempt (i.e. escape tax) if the individual survives for a period of seven years. These are typically outright gifts of cash or assets or the setting up of an absolute trust.

A CLT is a transfer of value by an individual. It is defined in the legislation as a transfer of an amount of value that causes the individual’s estate to diminish, but that is not an exempt transfer.

If the transfer is completely exempt it is not a chargeable transfer. However, there may be occasions where the exemption does not cover all the transfer of value, such as the marriage exemption or the annual exemption only covering part of the transfer. If only some of the transfer is exempt, the rest of it is chargeable as a CLT.

CLTs include gifts into discretionary trusts and are subject to 20% lifetime IHT above the available NRB, at the date of gift.

When someone dies, gifts in the last seven years need to be reviewed. PETs will become chargeable transfers, and gifts that were originally CLTs will need to be re-assessed. There's no tax on chargeable transfers that are cumulatively below the nil rate band (NRB). However, this will mean that there's less nil rate band available for other assets within the estate and it may mean the estate pays more tax as a result.

The nil rate band at death (including any transferable nil rate band form a spouse/civil partnership), is used to calculate the tax on chargeable transfers in chronological order. The earliest failed PET or CLT (failed meaning within 7 years from date of death) will get first use of the nil rate band.

The tax on chargeable transfers and failed PETs above the nil rate band at death will be recalculated at 40%. It's the recipient of the gift who is primarily responsible for paying the tax.

There's no tax payable on gifts made more than seven years before death. However, a CLT made more than seven years before death can affect the amount of tax payable on failed PETs or CLTs – “the 14-year rule”.

The tax on gifts in the seven years before death must be recalculated at the death rate of 40%. Any chargeable transfers in the seven years prior to the gift will reduce the available nil rate band for the gift being re-assessed, and so increase the tax on it.

PETs more than seven years old will have become ‘exempt’ and will not affect the tax on later gifts.

Relevant property trusts, such as discretionary trusts, are assessed to IHT every 10 years (periodic charge) or when capital leaves the trust (exit charge).

The trust has its own IHT nil rate band for calculating periodic and exit charges. But it will be reduced by any chargeable transfers, including failed PETs, in the seven years before the trust was created.

You take the start date of the discretionary trust and look for any previous CLTs created in the seven years before the trust was set up. If there are none, it means the trust, throughout its lifetime, will have 100% of whatever the NRB is at each ten-year mark. However, a failed PET (a PET within the 7 years before death) becomes chargeable and eats the NRB that the client needs now and at every ten-year point, going forward for the trust.

When considering any lifetime IHT on the actual CLTs, the order matters less as loan trusts and PETs can be ignored whether they are made before or after the CLT.

If, however, an individual is considering lifetime gifts in excess of the IHT nil rate band (NRB) they may choose to limit the CLT to no more than the NRB with the balance going to a loan trust or an absolute trust (PET).

If a client makes a gift of cash/assets or sets up an absolute trust and dies within seven years of the gift, the PET becomes a chargeable transfer. This has an impact on any CLTs created after the PET.

When you calculate the periodic or ten-yearly charge on a discretionary trust you need to know what nil rate band (NRB) is available for the trust. If the value of the trust fund at the ten-year mark exceeds the “available” NRB for the trust, there will be an IHT charge applied to the trust of no more than 6% of the excess.

This means it is important for the trust to have as much of a NRB as possible to use at every 10th anniversary.

PETs and CLTs drop out of the IHT cumulation after seven years, so if a client sets up a discretionary trust and creates a CLT it will normally drop out of their IHT calculation after seven years.

However, if they create a PET after the trust, this can expand the timeline for the CLT beyond the seven years and can potentially keep the CLT in the timeline for up to a period of 14 years. As under the IHT rules, it states that if a PET fails and becomes chargeable from the date of that gift, you look back seven years and pull in any previous CLTs.

If someone is planning to make a series of gifts, the order they are made can affect subsequent periodic and exit charges on the trusts. Gifting in the following order is likely to have the least impact on these charges:

1. Loan Trusts

   There's no transfer of value on the creation of a loan trust, but it is still subject to periodic and exit charges (unless it is an absolute trust).

   Creating a loan trust before a gift into another relevant property trust means both will benefit from a full nil rate band at the periodic charge date (assuming there are no other chargeable transfers in the previous seven years). If the order were reversed, the loan trust may have to pay IHT on an exit or periodic charge date because the prior CLT will reduce the loan trust nil rate band.

2. Chargeable Lifetime Transfers (CLT)

   These include gifts to all discretionary and most IIP trusts (post 2006). By making a CLT before a PET, should the PET become chargeable (i.e. if death occurs within seven years) it will not eat into the nil rate band available to the trust – it was made after the trust, not before it. This may reduce or avoid periodic and exit charges on the trust.

3. Potentially Exempt Transfers (PET)

   Outright gifts and gifts into absolute trusts are not subject to periodic charges. However, if a PET is made before a gift into a relevant property trust, it could reduce the nil rate band available to the trust if the donor fails to survive for seven years.

4. Exempt transfers

   Gifts which are covered by an exemption such as the annual exempt amount (£3,000), or normal expenditure out of income, can really be made at any time without consequence to the nil rate band available to a relevant property trust.

There are implications either way when doing IHT planning for clients where there is a mixture of PETs and CLTs. However, the best way to create gifts is to do the CLT first and then soon afterwards create the PET. This means that you are not expanding the 7-year timeline by much for the CLT and it gives the discretionary trust the maximum nil rate band at each ten-year anniversary, if the PET fails.

There is no IHT due on gifts if the donor survives for seven years after making the gift. If the donor fails to survive the seven years, IHT at the full rate of 40% may become due, especially if it is above or where there is a limited amount of nil rate band available. Taper relief is available depending on how many of the seven years were survived. After three years, the amount of IHT due “tapers” down until, after year seven, no IHT is due.

There are certain conditions applying to IHT taper relief:

• The total value of any gifts made within the 7 years prior to death must exceed £325,000 (the IHT threshold or nil rate band).

• The relief only applies to gifts.

• Taper relief reduces the IHT payable on the proportion of the gift over the IHT threshold.

• Gifts made within 7 years of death are counted first for IHT, before the value of other assets is counted. This is important to note especially if the value of your estate at the date of death (excluding gifts) is below the IHT threshold.