Look forward and back

While for some the Budget may have seemed uneventful, after the dust settled, those looking at inheritance tax (IHT) planning realised there was quite a large change that would affect both planning going forward but also that of the past.

One area that can be helpful in IHT planning is the use of loans. For example, if a non-UK domiciled individual wished to buy a UK situs asset, such as a house, without risking an IHT liability and without a complex structure, they could take a loan (potentially from a family member/trust/company outside of the UK) charged on the property. For IHT purposes, if a loan is secured on a property, IHT is only due on the balance.

In another example, an individual may wish to invest in assets that receive agricultural (APR) or business property relief (BPR) - a farm, for example, or an AIM portfolio - but not have the cash to do so. Taking a loan, charged to property that does not get relief, to purchase the IHT relievable asset would mean the property without the relief is sheltered to the full value of the loan and relief is also obtained for the new asset.

Removing tax advantage

HMRC announced in the Budget that it intended to bring legislation into force, from the date the Finance Bill 2013 receives royal assent, to remove the tax advantage. There was no forewarning of this and consultation has not taken place, as has been the case on such measures in recent years.

The legislation states that:

• Liabilities will only get a deduction where they are repaid. There are conditions in which the liability can be deducted if it is shown there were commercial reasons for it not being repaid.

• Liabilities will not be deductible from a general estate where the funds incurred were then used to buy property that is excluded from charge to IHT.

• Liabilities used to acquire assets that benefit from BPR or APR will reduce the value of the assets acquired.

The last two points are regardless of the asset the liability is secured on.

Where liabilities are repaid, if they are in excess of the property they were used to buy, the remaining balance will be available as a general deduction.

As the legislation applies to deaths (as well as chargeable transfers) that occur after the royal assent of the Finance Bill 2013 this legislation is therefore retrospective and will cover liabilities that are already in place as well as future liabilities.

Also, while this legislation is targeting those using liabilities to reduce their IHT exposure, it can also capture those that are entering into normal commercial transactions. For example, it is common when starting a business to perhaps take a mortgage against a house. On death, because the funds were used in the business, the liability will be offset against the business first, which may gain from 100 per cent BPR, and not against the house.

All individuals with assets in excess of their nil rate band (regardless of whether these are relievable) will need to take care before loans are taken out and review historic loans with respect to IHT planning.

Non-UK spouses

One welcome change to legislation was first announced in the 2012 budget and it was confirmed in the 2013 budget that it will be introduced in the Finance Bill 2013.

Transfers between UK-domiciled spouses, either in lifetime or on death are exempt from IHT. In addition, every individual with UK assets, whether UK domiciled or not can take advantage of the nil rate band of £325,000. However, previously when assets were transferred from a UK-domiciled spouse to a non-UK domiciled spouse there was a lifetime cap of £55,000 on assets that could be transferred free of IHT.

This cap has now been increased to the level of the nil rate bad, so it's £325,000 currently.

In addition, non-UK domiciled spouses can now elect to be treated as UK-domiciled for IHT purposes. This will allow an IHT-free transfer, although will bring the worldwide assets of the electing spouse into the UK IHT net.

Such elections are irrevocable when the non-UK domiciled individual is resident in the UK, but will cease to have effect once they have left the UK for more than four full consecutive tax years.

While this change is clearly positive, careful tax planning is still required for transfers between UK- and non-UK domiciled spouses and around a potential election to be treated as UK-domiciled.

Missing from budget

As the chancellor has stated, there was no indication of a future increase in the nil rate band and confirmation that it would remain frozen at its current level until 5 April 2018.

With this banding frozen, over the next five years more and more individuals and couples are going to find themselves in the position of having to pay IHT when in the past they would not have done.

Lucy Brennan is a partner in the private wealth team at Saffery Champness