Many taxpayers are aware of a ‘seven year rule’ for inheritance tax (IHT) purposes. They assume this rule to mean that if (for example) a parent gifts an investment property to their adult offspring, the gift will escape IHT if the parent survives at least seven years after making the gift.
Seven years…or is it?
Very often, this assumption will be correct if the gift is an outright one with no strings attached (i.e. so that the ‘gifts with reservation’ anti-avoidance rules do not treat the property as remaining part of the donor’s estate). However, lifetime transfers can have IHT implications for a much longer period than seven years in certain circumstances – possibly up to 14 years.
In the above example, the gift of the investment property from parent to child (i.e. being a gift from one individual to another) was a ‘potentially exempt transfer’ (PET). A PET becomes an exempt transfer for IHT purposes seven years after making the gift. It would therefore only become chargeable to IHT if the parent dies within seven years of making it.
By contrast, if the parent gifted the investment property into a discretionary trust for family members, the gift would be an immediately chargeable lifetime transfer (CLT). A CLT is aggregated with any other such transfers over a seven-year period. IHT is charged at the lifetime rate (i.e. 20% for 2019/20) on the transfer as the highest part of the aggregate total, to the extent that (after deducting any available reliefs and exemptions) it exceeds the ‘nil rate band’ (£325,000 for 2019/20).
IHT becomes chargeable at the ‘death rate’ (40% for 2019/20) on CLTs made within seven years of the transferor’s death. Thus on death the gift into the discretionary trust would be cumulated with CLTs and PETs in the preceding seven years, and IHT would be calculated accordingly (taking into account any lifetime IHT paid).
As mentioned, in some cases it may be necessary to take into account transfers made more than seven years before the date of death, up to a maximum of 14 years. For example, if a PET is made six years and 11 months before death, it would be necessary to look back 13 years and 11 months prior to the death.
However, normally the only transfers made more than seven years before death which need to be considered are CLTs.
Example: Lifetime gifts and death
Mr Smith died on 1 November 2018. He had gifted an investment property worth £200,000 into a family discretionary trust on 31 December 2009. He subsequently gifted another property worth £300,000 to his daughter on 1 January 2016. No other lifetime transfers were made.
(a) Lifetime gifts – The gift into the discretionary trust was a CLT, but no lifetime IHT was paid as the value of the investment property was within Mr Smith’s available nil rate band (£325,000 for 2009/10). The subsequent gift of a property to his daughter was a PET when made, so no lifetime IHT was payable.
(b) IHT on death – Mr Smith’s lifetime gift into the discretionary trust was made more than seven years previously, so no IHT is payable on death. The gift to Mr Smith’s daughter was a PET made within seven years of death, which therefore becomes chargeable. The gift to the discretionary trust (although made more than seven years before death) is cumulated, as it was made within seven years of the PET. The IHT position is:
Gift into discretionary trust – £200,000
Nil rate band remaining (£325,000 – £200,000) = £125,000
IHT on gift to daughter – £300,000:
£125,000 x Nil = Nil
£175,000 x 40% = £70,000
Note that if Mr Smith’s gift on 31 December 2009 had been a PET (e.g. another gift to his daughter) instead of a CLT, no IHT would have been payable on the gifts.
Consider the timing of lifetime gifts. If lifetime gifts are made at least seven years apart, it will not normally be necessary to look back more than seven years before death. Furthermore, making lifetime gifts up to the available nil rate band (after any available reliefs and exemptions) at least seven years apart can also be an effective way to mitigate IHT on the death estate.
The above article was first published in Property Tax Insider (March 2018) (www.taxinsider.co.uk).