Potentially Exempt Transfers
If you make a gift to someone and this is not covered by one of the exemptions or allowances, it is known as a ‘Potentially Exempt Transfer‘.
There is no Inheritance Tax charge at the time you make the gift, and you do not need to report it to HMRC. If you survive for seven years after making the gift, it will be ignored for Inheritance Tax purposes.
However, if you die within the seven years following the date you made the gift, your PRs will need to report to HMRC and Inheritance Tax will be calculated on the gift in the same way as the rest of your estate. If you die within 3 – 7 years, the rate charged will be tapered.
Exemptions that apply to lifetime gifts
A number of exemptions apply for lifetime gifts which can be found in the Inheritance Tax Act Sections 18 – 23. Where an exemption applies, the gift will have no impact on your estate for Inheritance Tax purposes.
Gifts to a spouse or civil partner
Provided that your spouse or civil partner is domicile in the UK, you can make an unlimited amount of gifts to them without impacting the Inheritance Tax due on your estate on death (i.e. they will not be treated as Potentially Exempt Transfers).
If your spouse or civil partner is not domiciled in the UK, there is a limit on the exempt amount that may pass.
Gifts to charity
Gifts to charities and political parties are exempt and will not affect the Inheritance Tax your estate pays on your death (i.e. they will not be treated as Potentially Exempt Transfers). There are some requirements that the political party must meet for this exemption to apply.
Other gifting exemptions
There are a range of other gifting exemptions, some of which are very valuable.
You can gift up to £250 to any one person in any one year. You cannot combine this exemption with another exemption.
£3,000 annual exemption
You can gift up to £3,000 each year (this might be to one person, or to more than one person). If you do not use the exemption one year, you can roll it over one year.
Steven and Lee did not make any gifts in the 2019/20 tax year. In February 2021, they each gave £6,000 to their son Oliver, totalling £12,000. These gifts would be exempt – each person has a £3,000 exemption for 2020/21, and each person can roll over the unused £3,000 exemption from the 2019/20 tax year.
Gifts in consideration of marriage
You can give the following gifts in consideration of marriage:
- £5,000 if you are a parent of one party to the marriage or civil partnership, or
- £2,500 if you are a remoter ancestor (such as a grandparent) or you are one of the parties to the intended marriage or civil partnership, or
- £1,000 if you are anyone else.
Normal expenditure out of income
The ‘normal expenditure out of income‘ exemption is incredibly valuable. It allows you to make unlimited gifts which meet these three conditions:
- The gift is ‘normal expenditure’ (for example, paying someone’s rent)
- The gifts are made out of your spare income
- You are left with sufficient income to maintain your usual standard of living.
There are no hard and fast rules as to what gifts will qualify here, since what ‘normal expenditure’ is for one person may not be the same as another. Even if only a single payment is made, it may qualify for the exemption if there is evidence of intention that further payments will be made (Bennett v Inland Revenue Commissioners  STC 54).
It is essential to keep records that demonstrate the above three conditions have been met for each gift.
The consequence of this exemption is that those with high levels of income can transfer substantial amounts, without impacting their Inheritance Tax position. Further, the gifts can be made either outright or into a discretionary trust (ordinarily a gift to a discretionary trust would immediately attract an Inheritance Tax charge). Such transfers must be reported to HMRC unless they fall within the nil rate band.
The exemption may alternatively be used to fund the payment of premiums of policies written into trust such as:
- Endowment policies written in trust by a parent for a child
- Where a gift has been made which is not covered by an exemption (i.e. a potentially exemption transfer), a policy written in trust that would fund any Inheritance Tax liability if the person making the gift dies within seven years
Gifts to support another person’s living costs
Payments made to help with another person’s living costs such as a dependent relative or one of your children aged under 18, are exempt. This is a lesser known exemption but again, can prove very valuable. There is no requirement to show that your standard of living was unaffected.