Failed PET revival for IHT

Gifts are generally outside of a person’s estate for inheritance tax (IHT) purposes if that person survives seven years from the date of the gift. Such gifts are known as ‘potentially exempt transfers’ (or "PET"s).

The issue

If the individual dies within seven years, then the gift ends up falling within the scope of IHT. Here, any gift over the nil rate band of £325,000 will be subject to IHT at 40%, although there can be some tapering of tax where over three years have elapsed between the date of the gift and death.

Generally, gifts of shares in trading companies which qualify for Business Relief (BR) will not end up being chargeable, even if the transferor dies within seven years. This is because these kinds of assets benefit from a full IHT exemption. However, this relief can only apply if they are still held at the date of death. If they have been disposed of before death, the full value, absent relief, becomes chargeable.

All may not be lost in such cases, because of a rule on Replacement Property...

This means that as long as the full sale proceeds are used to acquire Replacement Property (such as more trading company shares or shares in an AIM portfolio) within three years of the disposal of the original asset, then the PET will not fail on death. Surprisingly, this rule can even be used to rescue the situation after the death of the donor, which would otherwise have led to a chargeable gift.

Example

1. On 31 January 2018, Jose gifts his daughter Ivana shares in his trading company worth £1.5m.
2. On 31 January 2021, Ivana sells her shares for £2m.
3. On 30 November 2022, Jose dies, thus apparently leading to a chargeable gift with no BR.
4. Before 31 January 2024, Ivana invests the full £2m in AIM portfolio shares.

Here, Ivana’s acquisition of the AIM portfolio shares will have saved £360,000 of IHT after 40% tapering relief (assuming the £325,000 of nil rate band was used against earlier gifts). Even if Ivana is extremely risk averse, this strategy should still be attractive to her because there is apparently no minimum holding period for the AIM shares provided for in the legislation.

This point notwithstanding, I can see that HMRC may seek to attack a quick acquisition and disposal under anti-avoidance legislation.

Hamilton Rose's view

Sadly, the above scenario is not as unusual as we may all like to think. Sometimes, shareholder illness can itself trigger a business disposal and then there can be capital gains tax, as well as IHT reasons, for gifting the shares.

When gifts of BR assets fail in this way, there should always be an exercise to determine whether it is possible to reinstate this valuable relief. Even the most risk averse beneficiary should be able to see the benefit of a small dabble in the market if it could trigger an IHT windfall!