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What does HMRC consider to be a tax-exempt gift?

A readers asks for clarification of the tax treatment of gifts
July 28, 2022

My question is regarding inheritance tax and possible exemptions therefrom. I see a lot of useful stuff on this subject but while ‘gifts’ are mentioned frequently, I’ve never heard the word defined.

For instance, I book a holiday cottage and having done so, would like to have the family along for company.  Am I making a gift? My granddaughter likes riding so I buy and keep a horse, but only she rides it? Is that a gift? Similarly, my grandson likes driving and I buy a car. What about school fees?

Any clarification of this area would be a comfort.

PW

Stephanie Court, Private Client Tax Director at RSM UK

For what seems like a simple question, the answer for inheritance tax (IHT) purposes is quite complicated. A gift might ordinarily be defined as a thing given willingly to someone without payment in return. However, there is no express tax charge on ‘gifts’ defined in the IHT legislation; rather, tax may be charged on ‘the value transferred’ by a ‘chargeable transfer’. Let’s break down what that means.

The concept of a transfer of value is a key principle of IHT. A transfer of value, put simply, is a disposition made by a person as a result of which the value of their estate has decreased. The term disposition is not a technical one, but an ordinary word taken to mean any act by which any property is transferred by deliberate action.

A transfer of value also includes a deliberate failure to exercise a right resulting in a loss of value. The concept of the loss of value to an estate as a measure of the value transferred reflects the basic principle of IHT being a tax on a disposition by someone.

This definition is so wide, however, that it could catch any transaction that causes a loss in value to a person’s estate. For this reason, the IHT legislation specifically provides that a disposition is not a transfer of value if it is not intended to confer any gratuitous benefit on any person. For example, an arm’s length commercial transaction would not be a transfer of value, even if it caused a loss in value to the person’s estate.

Similarly, a disposition is not a transfer of value if made for the maintenance of family, such as, for example, a disposition made by one party to a marriage or civil partnership in favour of the other party or a minor child of either party, for their maintenance, education or training.

Dispositions can also occur where property is settled on trust, and there are a number of deemed dispositions and transfers of value, but let’s concentrate on dispositions from one individual to another individual here. Referring back to the ordinary meaning of gift being a thing being given to someone else, a ‘transfer of value’ will be considered a ‘gift to another individual’ to the extent that:

  • The value transferred is attributable to property which, by virtue of the transfer, becomes comprised in the estate of that other individual, or;
  • So far as that value is not attributable to property which becomes comprised in the estate of another person, the estate of that other individual is increased by virtue of the transfer.

Put another way, the categories of gifts to an individual involve value being removed from one person’s estate, and property being added to another person’s estate, or that other person’s estate being increased in value by virtue of a transfer. An example of the latter case may be an individual satisfying the debt of another individual: there is no property passing into their estate, but their estate is increased by the reduction of the debt.

The word ‘gift’ can therefore refer to any transfer of value satisfying these conditions. There is no additional requirement that there must be a gift in the ordinary sense of the word. For example, an individual who purchases an asset and allows its use at no cost by members of their family may be considered as gratuitous, but the action would not be a transfer of value for IHT purposes as the value of the asset remains within the individual’s estate.

So, when does a transfer of value, or gift, become a chargeable transfer? A chargeable transfer is defined as a transfer of value made by an individual which is not an exempt transfer. Exempt transfers include gifts between spouses and to charities, certain specific exemptions for small gifts, and transfers of value below the annual exemption of £3,000.

A transfer of value, or gift, made by an individual to another individual will generally rank as a potentially exempt transfer, otherwise known as a PET. A PET becomes an exempt transfer when more than seven years have elapsed between the date of the gift and the date of death. That is to say, a gift to another individual will be exempt from a charge to IHT provided the donor survives seven years from the date of the gift.

Note that the exemption for transfers of value for the maintenance of family does not extend to transfers made to individuals by their grandparents or other family members. Therefore, the provision of funds to allow for the payment of school fees of a grandchild would not qualify for the exemption and would be a transfer of value.

Most of the time, the payment of school fees would be considered a PET and become exempt from IHT after seven years. However, a transfer of value is exempt if it is made as part of the transferor’s normal expenditure out of excess income. In this way, subject to meeting relevant conditions, regular gifts towards the payment of school fees may be immediately exempt from IHT, rather than treated as PETs.