Potentially Exempt Transfers and Chargeable Lifetime Transfers

Understand Potentially Exempt Transfers and Chargeable Lifetime Transfers

Key rules to remember

Classification

Gift to an individual = PET; gift to a trust or a company = CLT (except bare trusts and certain disabled trusts, which are PETs)

Check the recipient first. A bare trust or certain disabled trust is treated like a gift to an individual, so it is a PET. Apply exemptions before classifying.

PET tax consequence

No tax when made; chargeable only if donor dies within 7 years

If death is within 7 years, tax is at 40% on the excess over the nil rate band remaining, with taper relief on the tax.

CLT lifetime tax

Tax (trustees pay) = 20% × (CLT after exemptions − available nil rate band)

Nil rate band is £325,000 less chargeable transfers in the previous 7 years. Use this formula only when the trustees pay the tax. If the donor pays, use the grossing up formula below.

Grossing up

Gross transfer = (net transfer − available nil rate band) ÷ 0.80 + available nil rate band; tax = 20% × grossed-up excess

Use only when the donor pays the lifetime tax. The tax works out at 25% of the net excess.

Taper relief

Reduces the tax (not the value) by 20% (3–4 yrs), 40% (4–5), 60% (5–6), 80% (6–7)

No relief if death is within 3 years. The ACCA table gives these percentages.

Death rate

40% on the excess over the nil rate band

Death within 7 years of a CLT: compute death tax at 40% on the gross transfer above the nil rate band remaining, reduce it by taper relief, then deduct lifetime tax paid (the result cannot be below nil).

How to solve Potentially Exempt Transfers and Chargeable Lifetime Transfers questions

1. 1Find the transfer of value: the fall in the donor's estate, not the value received. Remember any tax paid by the donor adds to the fall.
2. 2Deduct exemptions in the correct order: marriage or other exemptions first, then the annual exemption of £3,000 (current year, then the unused amount from the previous year).
3. 3Classify the gift: individual means PET, trust means CLT.
4. 4For a PET, state that no tax is due now. Compute tax only if the question says the donor died within seven years.
5. 5For a CLT, find the nil rate band left after chargeable transfers in the seven years before the gift. Apply 20% to the excess, grossing up if the donor pays the tax.
6. 6If death occurs within seven years, compute death tax at 40% on the gross transfer above the nil rate band remaining after chargeable transfers in the seven years before the gift. Apply taper relief to that tax if death is more than three years after the gift, then deduct lifetime tax paid. The result cannot be below nil, and excess lifetime tax is not refunded.
7. 7Do the transfers in date order, as earlier ones use up the nil rate band first.

Quickest way: Recipient, then date, then band

Common mistakes in Potentially Exempt Transfers and Chargeable Lifetime Transfers

• Charging tax on a PET when it is made.

  Students link every gift with tax.

  Fix: Write 'PET: no lifetime tax' unless death within seven years is stated.

• Treating all gifts into trusts as PETs.

  Confusing a gift to a person with a gift to a trust.

  Fix: Check the recipient. A discretionary trust gives a CLT.

• Forgetting the annual exemption of £3,000 before classifying.

  Rushing to the nil rate band.

  Fix: Deduct exemptions first, using any unused amount from the previous year.

• Applying taper relief to the value of the gift.

  The name sounds like it reduces the gift.

  Fix: Taper relief reduces the tax, and only when death is more than three years after the gift.

• Not grossing up when the donor pays the lifetime tax.

  Students forget the tax itself reduces the donor's estate.

  Fix: Divide the net excess by 0.80 and tax at 20%, or equivalently charge 25% on the net excess.

• Ignoring CLTs in the previous seven years when finding the nil rate band.

  Treating the band as £325,000 each time.

  Fix: List chargeable transfers back seven years and deduct them.

Worked examples