Gifting assets to avoid inheritance tax may result in income tax instead – why?
- TBA
- Jan 22
- 4 min read
Updated: Mar 13
In the UK, most people have heard of inheritance tax. If children inherit assets worth more than £325,000 from their parents, HMRC will levy this tax.
Therefore, many people arrange their assets for their children and family members during their lifetime. For example, parents may transfer assets to their children early to avoid the high inheritance tax through the seven-year rule.
However, you may not be aware that your situation could also involve a tax called Pre-Owned Asset Tax (POAT), which sometimes can be quite substantial.
What is Pre-Owned Asset Tax (POAT)?
POAT is a tax on pre-owned assets. It applies to assets such as property, land, personal valuables, cash, stocks, insurance products, and other intangible assets that people can freely gift during their lifetime. If, after gifting these assets, you continue to directly or indirectly benefit from them, you may be subject to POAT and required to pay income tax.
According to POAT rules, any income you derive from the gifted assets is considered your taxable income, and the tax value is based on the annual benefit derived from these assets. Typically, POAT is calculated based on the ‘enjoyment value’ of the asset, often equivalent to the market rent paid when the asset is leased on the open market.
This value is then taxed at your normal income tax rate. In general, POAT doesn’t take into account the asset’s income, but uses a fixed method to calculate the tax liability.
When are you required to pay POAT?
POAT applies to a wide range of situations. It includes not only gifting assets to family members but also placing them in trusts or selling them below their market value.
The purpose of POAT is to prevent people from avoiding inheritance tax by gifting assets but still benefiting from them. If HMRC can’t levy inheritance tax, they will find another way, such as through income tax.
In the context of inheritance tax, if parents gift assets to children and survive for seven years, the gifted assets are ignored when calculating whether inheritance tax is due. However, if they continue to benefit from those assets in some way, they must pay income tax according to POAT rules.
Common examples:
On 30 September 2012, Mr W and his wife sold their property and gave £450,000 (the proceeds from the sale) to their son to purchase a larger home. Later, when Mr W and his wife became elderly and frail, they moved into their son’s property rent-free. HMRC considered this as a POAT situation, and they were required to pay the tax.
On 24 December 2013, Mr W gave his son £300,000, which the son used to buy a rental property. Later, the property was sold for £600,000, and in 2017, Mr W’s son used the proceeds to buy another property, allowing Mr W to live there. HMRC considered this an indirect benefit, and POAT was applied.
GWR and POAT: The Difference
You might have heard of GWR (Gift with Reservation of Benefit) while reading about inheritance tax rules. Both GWR and POAT are anti-avoidance measures aimed at preventing people from avoiding inheritance tax. The key difference is that GWR still requires inheritance tax to be paid, while POAT requires income tax.
For example, if parents transfer ownership of a property to their children but continue to live in it, this is considered a gift with reservation of benefit (GWR). In this case, the property value will still be included in the estate for inheritance tax purposes when the parents pass away.
Taxpayers can also try to ‘benefit’ in other ways, such as selling their house and giving most of the money to their children, who then buy another property for the parents to live in. In such cases, POAT may apply instead of GWR.
How can you avoid or reduce POAT?
While POAT rules are strict, there are ways to reduce its impact:
Gift assets to a spouse: Transfers between spouses typically don’t fall under POAT rules.
Pay market rent: If you gift money to children who buy property for you to live in, you can avoid POAT by paying a fixed rent.
Fair trade disposal: If you dispose of assets to unrelated parties at fair market value or to related parties under fair terms, POAT may not apply.
Choose to pay inheritance tax: If the asset is included in your estate for inheritance tax purposes, POAT may be exempt.
£5,000 threshold: If the “appropriate rental value” in a given tax year is less than £5,000, POAT is not applied.
Certain assets may be exempt: Assets used for business purposes or with low value may be exempt from POAT.
In summary, as always, it’s important to consult a tax advisor to ensure you’re not violating any tax rules you might not be aware of.
What should you do?
If you find that your situation involves POAT, you must report these assets to HMRC every year. You need to inform them of the assets you continue to benefit from, their value, and the amount of tax you owe.
Make sure you handle these matters correctly, as failing to do so can result in penalties. Many people don’t realise this tax rule until they deal with the inheritance left by their parents and discover they are liable for POAT.
HMRC always has ways to collect taxes. They might notify the executor of your will about the tax liability when they are handling inheritance tax. If you face POAT issues and cannot afford or do not want to pay the tax, HMRC may offer solutions, such as opting to pay inheritance tax under the GWR rules instead.
The impact of taxes will depend on various factors, and expert advice is essential.