Budget puts stopper on deductible-loan IHT planning

21 March 2013

Yesterday's Budget Statement announced legislation to block inheritance tax (IHT) mitigation schemes that rely on deductions for liabilities owed by the deceased.

The current rules allow executors to deduct from the taxable estate any debts owed by the deceased at death, whether or not the liabilities are paid after death and regardless of how the borrowed funds have been used.

According to HMRC, this has been exploited by avoidance schemes involving contrived debts that are never repaid, so there is no real reduction in the value of the estate. The use of loans to acquire non-taxable assets reduces the value of the estate even more.

Prudential's Gerry Brown TEP cites an example of a scheme in which a person sells an asset to his wife in return for her IOU. When she dies the IOU is deducted from her estate even though the husband never intended to recover the ‘debt’.

In future, where debts are not repaid on death, the executors will have to demonstrate a commercial reason for retaining the debt, not simply a desire to obtain a tax advantage. If they cannot, HMRC will not allow the debt to be deducted from the estate for IHT purposes.

The new legislation will also target schemes in which the deceased took out loans to buy property that is either exempt from IHT or for which IHT relief can be claimed. This could be so-called ‘excluded property’ sited outside the UK and owned by a non-dom; or business property such as shares in trading companies, or agricultural land.

Such debts will in future not be allowable against other non-relievable or relevant property. Instead the debt will usually be taken to reduce the value of those assets. However the deduction may be allowed if the acquired property has already been disposed of or where the liability is greater than the property value.

The new rules will also apply to trusts, except that the unpaid liabilities rule will not apply when calculating the estate's value for the purposes of the ten-year anniversary charge.

According to Sophie Dworetzsky of tax advisors Withers, this rule may have significant consequences for many individuals. Existing IHT planning arrangements will have to be reviewed to ensure that they are still effective, she said.

‘Much IHT planning will now need to be revisited’, added tax advisors BKL. "Coupled with the fixing of the nil-rate band at GBP325,000 until 2018, IHT is becoming a problem for more and more people.’

No consultation has taken place on the new measure, which could affect some hundreds of estates. There are concerns that the measure will cast too wide a net. Stephen Barratt TEP at accountancy firm James Cowper said farming estates could be particularly vulnerable to the effect of these changes.

The full details will become clear when the Finance Bill is published on 28 March. The measures will take effect when the Finance Bill receives royal assent.

 

 

Sources

 

HMRC (Overview of budget measures as PDF file)

UK Parliament (Budget statement)

Withers

Citywire

IFA Online

Farming UK

 


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