Finance Bill attack on IHT debt reliefs will catch many innocent situations

18 April 2013

The full implications of the Treasury's new restrictions on setting-off an estate's debts against inheritance tax (IHT) have now become clear.

The new rules appeared without warning or consultation in last month's Finance Bill. They abandon the previously accepted concept that IHT is charged on the net estate, i.e. total assets less any debts, such as mortgages.

If the rules are enacted as planned, the estate's outstanding loans will not be deductible in three particular situations. These are: where money borrowed is either invested in assets for which IHT relief is given, invested in assets excluded from IHT, or where the loan is not repaid by the executors. The changes in the legislation are clearly designed to attack tax planning where home loans were taken for investment in third party assets qualifying for business and agricultural property reliefs, or arrangements such as Employee Benefit Trusts.

But they will have retrospective effect on many estates where the deceased did not create the debts with the aim of reducing IHT, say experts.

Gary Heynes, a partner at tax advisors Baker Tilly, cites examples. One is where the deceased raises money by mortgaging their home to invest in their business. Assuming the trading business qualifies for full business property relief from IHT (as is usual) the full value of the house will now remain chargeable. ‘It is disappointing that normal commercial arrangements, such as funding one’s own business, would have relief denied,’ says Heynes.

Another example is where an elderly testator receives a loan from a family member. Often such loans are written off on death, but under the new rules the executors will have to pay off the loan to make it allowable as a debt against the deceased’s estate.

A third case would be that of a non-UK domiciled individual  who borrows money against UK property and takes the money outside the UK, for example to buy an overseas property. HMRC could then deny debt relief for the loan as the non-dom's overseas assets are generally excluded from IHT. Many non-UK domiciled individuals will be caught by this change, says Heynes.

This is the second major change in IHT legislation to be introduced without prior warning, the first being the reclassification of specialty debts affecting non-resident trustees. But the disqualification of debts from IHT is likely to hit a much larger group of people, says Heynes: ‘Inheritance tax changes which were not forewarned or consulted on are likely to catch a wide range of innocent situations.’

‘Some business owners may now have to budget for unexpected IHT bills,’ says Julie Steel, a family business advisor at KPMG. ‘They could be faced with a horrible choice – should their heirs sell the family home, or will the business pick up the tax bill?’

The UK Technical Committee is responding to the draft legislation on behalf of the Society.

 

Sources

 

Baker Tilly

East Anglian Daily Times

HMRC (Overview of budget measures as PDF file)

STEP UK Lead story of 21 March 2013


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