Without warning

Was HMRC right to pull the rug from under the feet of clients '¨in its U-turn on specialty debts and inheritance tax planning? Fay Copeland asks

How safe is tax planning in the current political climate? It's a question to ask since HMRC published an update to its inheritance tax (IHT) manual on the treatment of specialty debts for legitimate IHT purposes.

Previously, it was accepted that the main type of specialty debt (due under a deed opposed to a simple contract debt) was situated for IHT purposes where the deed was located.

However, HMRC now believes such debts are situated where the debtor lives. This has an impact on individuals (mainly non-doms) and beneficiaries of trusts with a non-dom settlor, both of which make use of the 'excluded property' rule to create debts that are held offshore and thus outside the IHT net. If the debtor is a UK resident, the debt will now be chargeable to IHT according to HMRC.

Is this change right? Most practitioners, it seems, say no. And it's because of how HMRC delivered its view: a unilateral statement, without prior warning or consultation, and with no transitional period before taking effect. There was no detailed reason for the change - just that the previous approach was "unlikely to be correct". Says who? And on what basis?

The old situs principle represents centuries of established legal practice and case law. It is relied on not only by UK taxpayers, but also by foreign courts. Therefore, the issue of whether or not it is correct is almost beyond question.

HMRC's view cannot be legally binding, of course, and we must await a test case before the administrative courts - a judicial review of a HMRC ruling in favour of its view - before we have clarity. It is likely that the affected taxpayer will be able to argue that they had a 'legitimate expectation' that their specialty debt would be assessed to IHT in line with the approach HMRC has consistently applied previously.

Legitimate argument

There was no reasonable notice or explanation for HMRC's change of view. This coupled with the fact that it looks to apply the change retrospectively with immediate effect, and has not been instigated by the courts, will support a 'legitimate expectation' argument.

Many would be surprised if the courts upheld HMRC's view. But if they did, would this give us enough clarity? There is a school of thought that believes even a decision of the Supreme Court supporting HMRC's view could not overturn the specialty/situs principle because of its long-established status - it would require legislation from parliament to do this.

This leaves us in a grey area. Clients with specialty debts should at least consider the risk that their arrangements could no longer work, and the consequences of that; but pending a test case, many clients may reasonably leave their specialty debts as they are, or perhaps find alternative ways of sheltering their assets using the excluded property rule.

No time

It leads back to the safety of tax mitigation these days. Clients, particularly non-doms, should be aware that any form of planning that seeks to avoid tax is at risk of attack from the government.

The worrying message from the specialty debt experience (and to a similar extent from the announcement in the Budget on the deductibility of loans for IHT), is that changes could be made at any time without warning, with no opportunity for taxpayers to unravel their planning before the amendments come into effect. In particular, this puts those without time on their side, elderly clients for example, at a disadvantage.

Difficult times lie ahead; that's all we know.

Fay Copeland is partner and head of private client at Wedlake Bell

She writes the regular comment on inheritance in Private Client Adviser

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