Technical Note 11 – Inheritance Tax and gifting

Is it a PET? Is it a GWROB? No it’s a POAT

Some features of Inheritance Tax (IHT) are well understood, such as the Nil Rate Band – the first £325,000 of an estate is entirely exempt from IHT, and for married couples this is doubled to £650,000. In my first Technical Note I discussed the Residence Nil Rate Band which will eventually give home-owning married couples with direct descendants a total IHT exemption of £1 million.

The PET is also fairly well understood. People know that you can give away assets to remove them from your estate, but that you have to live for seven years from the date of the gift. After those seven years are up the gifted asset is fully exempt, but during those seven years it only has the potential to become exempt, so it is a Potentially Exempt Transfer of assets.

If I give you my vintage Bentley (no, I haven’t got one!) it’s yours from day one, but it is a PET (the gift that is; the car is still a car, though you might treat it like a pet). If I die before seven years are up, the day-one value of the car goes back into my estate and tax applies on a sliding scale. But let’s say I make it a condition of giving you the car that you let me drive it at the occasional rally. In this case it’s not a PET, it’s a GWROB, a Gift With Reservation of Benefit, and it is treated as if it never left my estate. Although I’ve given you the car, I’m keeping, or reserving, some benefit for myself. Interestingly, if I don’t drive it, but merely accept an occasional lift, then it may not be a GWROB, although ‘occasional’ is the key word – a lift to the Red Lion every Sunday would probably be seen as an enjoyable benefit, and thus a GWROB.

So I’m not going to give you the Bentley. Instead, I’m going to park it at my parents’ house where they have a large secure garage. They have said they want to give me the house anyway, so long as they can carry on living there, and that way I get an early inheritance. But that’s a GWROB too. My parents might have given me the house but they’re keeping the benefit of it for themselves. They could pay me a market rent, which removes the GWROB issue, but then I’d have to pay income tax on that rent.

So what if my parents give me some cash which I can use to buy a new house with a big garage? Once they have sold their own house they can move into the granny flat on the side of my new house. The cash is a PET, and they aren’t reserving any benefit, since they’re selling their house. We’ve sorted it then, provided they live seven years. Well no, we haven’t. POAT, Pre-Owned Assets Tax, raises its ugly head. This is an annual charge to income tax where benefit is derived from an asset you used to own, but which isn’t caught by the GWROB rules.

POAT is a horrible and wide-ranging tax. It doesn’t only cover property, it also includes chattels (pictures, furniture, boats, cars, etc.) and intangibles (debts, insurance policies, royalties, stocks and shares, and so on). There are ‘tracing rules’ to follow gifts used by the donee to buy assets from which a benefit is derived by the original donor.

Here are two examples given by HMRC: Trevor gives a painting to Paul. Paul then sells the painting and buys a violin with the proceeds, which Trevor then plays. Here, the ‘disposal condition’ is met, Trevor has disposed of an asset but gets benefit from another asset acquired because of it. Or, Trevor gives Paul the funds to buy a painting. Paul then sells the painting and buys a violin with the sale proceeds, which Trevor then plays. Here, the ‘contribution condition’ is met, Trevor has made a contribution that has ultimately bought an asset he then enjoys. If Trevor had just gone out and bought himself a violin all we’d be talking about now is how to afford the lessons!

POAT is a fiendishly complicated tax which I have barely touched on here. As well as the three areas of property, chattels and intangibles, and the two conditions, disposal and contribution, there are various exemptions and exclusions. These might be inter-spousal; for family maintenance; for periods of non-residency; as a result of a court order; or annual and small gifts exemptions. And there is a minimum threshold which might allow an escape but which could be breached when an asset is periodically revalued. And since it is an annual tax the mandatory revaluations could prove to be expensive.

All we can say is that if it’s not a PET or a GWROB, then it might be POATable, and this just serves to demonstrate that where Inheritance Tax is concerned there are no easy shortcuts or ways out. And I’m keeping the Bentley.

Philip Chandler FPFS, CFPTM, Chartered MCSI

Chair of Aspinalls Technical and Investment Committee