Give and take

When the government introduced the new rules on the deduction of debts for inheritance tax (IHT) purposes, it came as a surprise to many, not least because of the lack of consultation before the Finance Bill 2013.

A formerly effective IHT planning tool was suddenly subject to new restrictions and not automatically available in many cases where it had been before. For some, the flexibility and usefulness of the old rules had perhaps been underestimated until they were, without warning, no longer an option when considering standard IHT planning.

Under the old system, liabilities entered into during lifetime could be deducted when calculating the value of an individual's assets chargeable to IHT on their death. This included being able to allocate a debt against an asset in an estate at the date of death, even if the debt was not incurred originally in relation to that asset.

The new rules set out that a deduction of a debt is allowable provided that there is actual repayment of the debt from the estate after death. Gone are the times when a debt was created in lifetime only for that debt to be forgiven after death, but still available as a deduction for IHT purposes. This change on the previous stance also flags up a practical point when dealing with estate administration: does repayment have to take place before the IHT return is submitted to HMRC?

While this was initially unclear, HMRC guidance, included in its October 2013 IHT manual, says that "as the majority of liabilities taken as deductions against an estate will be at arm's length, the starting assumption is that all liabilities will be repaid. So, unless the personal representatives are aware beforehand that a liability is not going to be repaid and it is not otherwise allowable as a deduction, the IHT400 notes allow the personal representatives to include all the deceased's liabilities when filling in the IHT400".

At least this means that personal representatives can move towards obtaining a grant of representation without having to prove in the early stages that the debt has been repaid. If it turns out that the debt will not be repaid, the personal representatives will submit a corrective account in the usual way.

New caveats

There are caveats to the new restrictions on non-repayment of debts. A debt can still be deducted on death, even if it is not repaid, if the following all apply: there was a genuine commercial reason for the liability not being discharged (i.e. dealings with someone at arm's length), securing a tax advantage was not the main purpose of leaving the liability wholly or partly unpaid and there were no other legislative provisions preventing the liability being taken into account.

The new rules also target liabilities that are attributable to financing either directly or indirectly the acquisition of excluded property (or for its maintenance or enhancement) and those attributable to buying business property relief (BPR) or agricultural property relief assets.

For example, where an individual borrows money to buy shares that qualify for BPR and they secure their borrowing against their UK house, on their death, the value of the loan will be deducted against the value of the shares first and BPR will be applied to the balance of the value of the shares. The loan will no longer be available to reduce the value of the UK house for IHT purposes.

The subtle meanings of 'directly' and 'indirectly' also need to be carefully thought out in each case - the HMRC manual considers that incurring a liability to buy excluded property and leaving the purchase price outstanding is direct, not indirect, financing.

While the rules are still relatively new, they remind us of the ever-changing landscape of UK tax mitigation arrangements. It is not just complex tax-relieving arrangements that can be targeted but also the standard ones. And what has previously worked as a straightforward mechanism for IHT planning purposes can be taken away without advance notice.

Anna Bruce-Smith is an associate at Penningtons Manches

The firm writes a regular blog for Private Client Adviser

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