An area where Druces’ Contentious Probate Team see regular disputes is the burden of Inheritance Tax (“IHT”) on gifts following death.
Most people are aware of the ‘seven-year rule’, meaning that gifts made in the seven years before death may be taken into account when assessing an estate’s exposure to inheritance tax. These gifts are ‘Potentially Exempt Transfers’ (“PETs”), meaning they are (as the name suggests) only potentially exempt from IHT.
Who pays Inheritance Tax on gifts following death?
If cash or an asset which has been gifted is caught in the IHT ‘net’ as a result of the Donor’s death, and that gift exceeds the available tax-free allowances, the primary liability for the tax due on that gift falls on the Donee (i.e. the person who received the gift).
Taper Relief and unexpected HMRC tax bills
Tax due can be reduced by Taper Relief, such that the tax rate is effectively lowered if the Donor survives between 3 and 7 years. However, the effect of this rule means that sometimes unaware beneficiaries are presented with a tax bill from HMRC following their parent/family member’s death, for an asset they received many years ago.
This can be particularly problematic, leading to family disputes and unnecessary litigation if all parties are not up to speed on the legal effect of the rules. This can be even more tricky where the executors and/or residuary beneficiaries are different family members to the receiver of the gift, such that their interests are in direct conflict (as can happen regularly, particularly in modern blended families).
Can a Will shift the burden of Inheritance Tax on a gift?
Sometimes the outcome is not what the deceased would have wanted. With proper advice, the position can be displaced by an appropriately drafted Will shifting the burden of tax from the beneficiary to their residuary estate.
This would mean that the tax on the asset gifted will be paid from the residue of the estate before distributions are made, i.e. such that the PET is given knowingly IHT-free.
Life interest trusts and unintended ‘failed PET’ consequences
Another area which can bring the unintended consequences of a ‘failed PET’ is where a life interest has been left to a surviving spouse and is then released by them to provide the capital to their children.
A spousal life interest is a type of trust which provides the survivor with a right to the interest/income on a share left to that widow, but with no direct access to the capital. This can be a particularly useful tax planning tool to take advantage of the spouse exemption from IHT on the first death, but ensuring the capital is preserved for their ultimate intended beneficiaries.
If the surviving spouse then decides to give up their life interest trust to their children, this is also considered a gift by them (and therefore a PET). Should the widow fail to survive seven years, all the above applies.
How can the risks of failed PETs be reduced?
There are many ways these issues can be mitigated from the outset:
Take advice. Druces’ Private Wealth team see this from both sides. Those who obtain proper tax planning advice are less likely to end up with family who instruct our contentious team to deal with the fall out.
Communication. Though one size does not fit all, we encourage most clients to keep their family members engaged and involved with their succession plans.
Insurance. Indemnity insurance can be taken out by a beneficiary to insure against the consequences of ‘failed PETs’. This can be particularly useful if the asset is illiquid, such as a property, or if the beneficiary needed cash at the time and no longer have the asset itself to set against the tax bill.
Druces’ teams are able to advise on the breadth of the issues above, from the correct advice at the outset, alternatively to guiding you through a dispute if one arises.
The Druces Contentious Probate Team will be attending the ConTRa conference in Lisbon from 18–20 March 2026. We look forward to engaging with colleagues in the contentious probate community and discussing other complex and technical matters. Our team will comprise of:
Paul Levy, Partner, Head of Contentious Trusts & Probate
