Inheritance Tax: The 7-year rule.

  • Posted

A Freedom of Information request by the Telegraph identified that since 2016, HMRC have found gifts worth more than £600 million have been deemed taxable at a rate of 40%. Whilst it is undeniable that making lifetime gifts is an excellent tool to mitigate an individual’s inheritance tax (IHT) liability, it is important to bear in mind the following rules before embarking on this aspect of tax planning.

This note develops certain issues addressed in an article on our website relating to Inheritance Tax and gifts. https://www.ibblaw.co.uk/insights/inheritance-tax-and-gifts . In particular, by exploring the 7-year Rule and the rules surrounding gifts with a reservation of benefit.

7 Year Rule

Most gifts (except those into most forms of trust) are not subject to IHT when they are made irrespective of their value.  Further, if you survive the making of those gifts by 7 years, they will be exempt from IHT. These types of gifts are known as potentially exempt transfers (PET).  The reason they are known as “potentially” exempt, is if you do not survive 7 years from the date of the gift, the gift will be subject to IHT.

The amount of tax that is charged depends on how long you survive from the date the gift was made.  The longer you survive after making the gift, the lower the IHT, provided you survive by at least three years. This is known as “taper relief” and is provided for by S7(4) of the Inheritance Tax Act 1984.

The way taper relief is calculated is shown in the table below, but it is important to note that taper relief applies to the level of IHT due and not the gift:

Period between the date of gift and date of death Rate of taper relief (applied to the amount of IHT)
0-3 years 0%
3-4 years 20%
4-5 years 40%
5-6 years 60%
6-7 years 80%
7 years and over 100%

 

For example, if you make a gift of £500,000 and die within three years, the IHT due on the gift (ignoring any other allowances except the nil rate band) would be £70,000. If you survive by more than three years, the IHT is £56,000.  You should bear in mind that the liability for the tax is on the recipient of the gift and not your estate.

Gift with a reservation of benefit

With the above mind, for a lifetime gift to be fully effective, at least from an IHT perspective, you must not fall foul of section 102 of the Finance Act 1986. This piece of legislation confirms you must give the property away without retaining a benefit or enjoyment in the property given away. If you do, the gift will be regarded by HMRC as a GROB (gift with a reservation of benefit) and will remain part of your estate for the purposes of calculating IHT.

Interestingly, the overwhelming majority of gifts which were found to be GROB’s related to property. The typical situation would be where a parent transfers the legal title of his or her property into the names of their children who live elsewhere. The parent then continues to live in the property rent free until the date of his or her death. In this scenario, it will certainly be the case that this “gift” will be regarded as a GROB.

In the alternative, if the parent in the above scenario moves out of the property, or pays his or her child full market rent, this will be a PET. Provided the parent survives 7 years from the date of moving out or the date rent began to be paid, the value of the property will be exempt from IHT.

The legislation states that the property must be enjoyed to the “virtual exclusion” of the donor. Whilst there can be some room for a minor reservation of benefit, for instance social visits to the property or staying over temporarily, it is important that the gift is made with no strings attached.

Making these types of gifts requires specialist advice as there are a number of factors to bear in mind.

Speak to our Wills, Trusts and Probate specialists.

If you have any questions regarding Inheritance Tax, contact our please contact IBB’s Wills, Trusts and Probate team on 01895 207 910 or email wills@ibblaw.co.uk.