Potentially Exempt Transfers

Broadly, when an individual dies, inheritance tax is payable if the combined value of their assets and any gifts made in the previous seven years exceeds the inheritance-tax nil-rate band, which is £325,000.   

Lifetime gifts that are outright gifts between individuals are exempt from inheritance tax provided the donor survives seven years from making the gift; such transfers are called potentially exempt transfers (PETs) because these are only potentially exempt from inheritance tax until their seventh anniversary has been reached.  A liability could, therefore, arise on the donor’s death within seven years of a gift, in which case the PET fails and becomes a chargeable transfer.

The rate of inheritance tax on failed PETs and a deceased’s estate is 40%; failed PETs are valued against the nil-rate band chronologically, where multiple PETs have been made, before any residual amount is applied to the estate.

Lifetime gifts can be exempt from inheritance tax

Accordingly, bearing in mind the necessary seven-year survival period, inheritance tax planning beyond a certain age can be particularly problematic.

Lifetime gifts could, however, be partially or fully exempt from inheritance tax, without having to wait seven years, owing to the availability of certain exemptions, namely the annual exemption, small-gifts exemption and the normal-expenditure-out-of-income exemption. These exemptions can assist those who intend on making relatively modest, regular gifts whereas ad hoc gifts of cash and assets to individuals would likely create potentially exempt transfers.

Many people are uncomfortable with the notion of relinquishing control of their cash and/or assets.   They may, therefore, also want to explore investments that utilise inheritance-tax business relief as these aren’t taxable once they have been owned for two years. This can be useful for more experienced investors who are willing to invest in riskier assets.

Although arrangements predicated on business-relief qualification are effective for inheritance tax planning, especially for those who may not survive seven years, they are often viewed as higher risk.  Hence, they are not suitable for all individuals, wishing to undertake inheritance tax planning.

For this reason, PETs could still be the preferred solution.  Moreover, the usual tax rate potentially arising from such gifts is reduced under the taper-relief provisions on the donor’s demise between three and seven years after the gift.

PETs & Taper Relief

A PET is usually a gift from one individual to another, which can comprise cash, investments, property, jewellery, antiques, etc.  There is no limit to the value of a PET that an individual can make.

If a PET does become chargeable to inheritance tax on a donor’s death within seven years, it’s normally chargeable based on its value when made, rather than on its value at the donor’s death, net of any available inheritance-tax nil-rate band. Thus, any growth in an asset’s value will be immediately outside the donor’s estate.  

On an individual’s death, gifts made in the last seven years are first set against any available inheritance-tax nil-rate band, which has been frozen at £325,000 until April 2028.  When determining any tax due, PETs made in the preceding seven years are set against this nil-rate band in chronological order: only PETs made in this seven-year period that exceed the nil-rate band, cumulatively, will be subject to inheritance tax.  Therefore, later PETs are more likely to instigate a tax charge than earlier ones.

A PET will be charged to inheritance tax at the rate of IHT that applies in the year of death, or (if lower) the year in which the PET was made. If the PET is fully within the nil-rate band, there will be no tax to pay in respect of it. Any tax that is due will be payable by the recipient of the PET.

So, if the value of the gift was covered by the donor’s nil-rate band, taper relief is not relevant.  However, the disadvantage of this scenario is the PET would use some or all the nil-rate band that would otherwise have been available to reduce the estate’s inheritance-tax liability.

Taper relief is an inheritance-tax relief that applies to the tax payable on failed PETs, namely those made within seven years of the donor’s death.  HMRC allows a reduction in the tax payable, depending on the timing between the gift and death.

Years between gift and deathPercentage of full tax rate (%)Tax rate (%)
 1 to 3 10040
3 to 48032
4 to 56024
5 to 64016
6 to 7208

It’s important to note taper relief reduces the rate of tax payable, as opposed to the PET’s value for the purpose of calculating the donor’s cumulative total of PETs where multiple PETs have been made.  As a result, it wouldn’t ameliorate the position of later gifts including the charge on a deceased’s estate.


For those willing to either make outright gifts or gifts to certain trusts, which afford donors some ongoing control of the gifted capital, there are opportunities to substantially reduce prospective inheritance-tax liabilities.

If you would like discuss matters covered in this article or indeed any other matter relating to inheritance tax planning, please do not hesitate to contact us.


The information included within this presentation is for general information only and is not intended to address the particular requirements of an individual.  In particular, the information contained within the article does not constitute any form of advice or recommendation by MWM.   The information should not be relied upon by individuals in either making or refraining from making any investment decisions.   Where necessary, individuals should seek appropriate professional advice before acting on any of the information contained in this article.

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