24 April 2023

Gifts made from an individual to other individuals are “Potentially Exempt Transfers” (PETs) for inheritance tax purposes: “potentially exempt” because, provided the donor survives for seven years, the property they gave away ceases to be included in their inheritance estates. However, If they should die within that period, the gift forms part of their estate on death and is taxed together with the rest of the assets they continue to own at their death.

But who is liable to pay the tax on that property, the person who received the property, or the personal representatives of the deceased? Legislation provides that the recipient of the gift and the personal representatives of the donor can both be asked to pay any tax. However, crucially, HMRC can only come to the personal representatives if the tax has not been paid within 12 months (or for some reason there is no one else to pay it). That puts the primary liability on the recipient, but only during that first 12 month period. HMRC are very clear in their manual that they do not treat the personal representatives as a soft target and will make all attempts to pursue the recipient first. On top of that, the recipient may also be a beneficiary of the estate, so the personal representatives can withhold his share pending settlement of the tax, which gives them additional protection.

In some cases an individual (referred to as the “life tenant”) will have a life interest in a trust which is a “Qualifying Interest in Possession” (QIIP) for inheritance tax purposes. Typically, that will be the case where the interest in the trust existed before 2006 or was created in the Will of a deceased spouse. The inheritance tax rules treat the assets subject to the life interest as if they belonged to the life tenant, though they are owned and controlled by the trustees. Accordingly, transfers out of these trusts to individuals are treated as if they are PETs made by the life tenant, and subject to the same seven year rule described above.

Although the tax treatment of gifts out of QIIP trusts is aligned with gifts made by individuals, the liability to actually pay tax is different in at least two important respects.

First, the primary liability to pay tax rests on the trustees. The recipients of the gifts are also liable, but only if the trustees fail to pay the tax on time. This is the reverse of the position for gifts made by individuals. Therefore, the trustees may find themselves exposed if they have not kept a reserve and the tax falls due at a time when the recipients have spent all of the money, even if they have taken the precaution of obtaining indemnities from the recipients.

Second, it is arguable* that the provisions of section 52 of the Inheritance Tax Act 1984 treat gifts made to several individuals as a single PET where they are all made under the same exercise of the trustees’ power (i.e., typically, on the same day and in the same document). The result is that each recipient of a gift may be jointly and severally liable for the tax on all of the gifts. The only cap on that liability is the value of the assets received by or applied for the benefit of that recipient (not just the tax on them). Each recipient can sue the other recipients to pay their share of the tax. However, if the others have spent what they have received, they may have nothing left to pay the tax with. Thus the prudent recipient who has saved his money may find he is called on to pay it all to HMRC.

Trustees who are considering a gift out of a QIIP settlement should always consider insuring against the tax risk and retaining a reserve for any uninsurable element. Recipients would be well advised to ensure such provisions are in place, so that the sums they each receive are protected against other recipients.

*See Executors of Patch (deceased) v Revenue and Customs Commissioners; SpC 600 [2007] STC (SCD) 453 in which s52 appears to have been interpreted in this way.

Written by Tom Bradfield and Tim Williams.


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