October 22, 201401962 776442info@lawskills.co.uk

Finance (No.2) Bill 2013 – Changes to the deduction of liabilities for IHT – Are they fair?

Home / Tax / Finance (No.2) Bill 2013 – Changes to the deduction of liabilities for IHT – Are they fair?
LawSkills provides training for the legal industry and does not provide legal advice to members of the public. For help or guidance please seek the services of a qualified practitioner.

Finance Bill 2013 - changes to deduction of liabilities for IHT

Changes to deduction of liabiities for IHT - are they fair?Out of the blue and without consultation the Finance Bill when published contained a shocking provision tucked away in Schedule 34.  It is a devastating provision for many farmers and business people BUT there appears also to be a harsh outcome for many other clients too, which may be unintentional.  It will affect a large proportion of your clients.

The Current Position

Currently, usually all liabilities outstanding at the date of death can be deducted from the net value of a deceased person’s estate before the application of Inheritance Tax.  The deduction is given for the full value of the liabilities due, rather than the amount actually repaid.

A Summary of the changes

1. In future in calculating the value of estates:

(a)debts attributable to the financing of:

(i) excluded property (ie property which is outside the scope of IHT such as non-UK property held by non-UK domiciled persons); or

(ii) property which can benefit from business property relief, agricultural property relief or woodlands relief;

will be deducted from the property they are attributable to (ie the property which is not subject to IHT) and not other property in the estate.

2. Any liability will only be taken into account in determining the value of an estate where the debt is discharged on or after death out of the estate in money or money’s worth unless:

(a) there is a real commercial reason for the liability or part not being discharged; and

(b) the liability or part is not left undischarged as part of arrangements the main purpose or one of the main purposes of which is to secure a tax advantage.

Where are the changes?

The changes are in Schedule 34 to the Finance (No.2) Bill 2013 and insert new Sections 162A-C and 175A IHTA 1984.

When do they take effect?

The changes take effect for all deaths and other transfers of value on or after Royal Assent which is expected to be around mid-July 2013.

Debts attributable to the financing of excluded property and relievable property (Sections 162A-C)

Debt attributable to the financing of the acquisition of excluded property, property falling within BPR, agricultural property or woodlands; or the maintenance or enhancement of the value of such property is deducted from the value of that property before other property in calculating the value of the estate.

For example, a farmer, Mr Brown borrows £1million to buy farmland and it is secured on his home (not within APR) worth £3 million.  Currently the trustees of his estate could set the £1m borrowing against the £3m house.  After the changes the £1m has to be set against the farmland and therefore the full £3m house value is within the estate.

If the value of the debt exceeds the value of the relievable assets then the remainder may be set against the rest of the estate. If the value of the debt exceeds the value of excluded property the excess can only be set against the value of the rest of the estate where that excess does not arise from tax avoidance arrangements; or an increase in the amount of the liability (whether due to accrued interest or otherwise); or a disposal in whole or part of the excluded property.

If the excluded property has been disposed of in whole or in part for full consideration the liability may be taken into account to the extent that the consideration is within the charge to IHT and has not been used to acquire, maintain or enhance further excluded property or repay a liability that itself would not be allowable.

When the debt is discharged there is a priority rule to determine how the repayments are applied.  The part of the liability which is not attributable to non-IHT assets is treated as paid off first.

Undischarged liabilities

In order to be deducted from the value of an estate any liability must be discharged on or after death out of the estate in money or money’s worth unless:

(a) there is a “real commercial” reason for the liability or part not being discharged; and

(b) the liability or part is not left undischarged as part of arrangements the main purpose or one of the main purposes of which is to secure a tax advantage.

“Arrangements” has the usual wide definition and “tax advantage” is defined not only to include a relief from tax, repayment of tax and avoidance of tax, but also the avoidance of a possible assessment or determination.

Examples of possible problems may include old Nil Rate Band discretionary trust (NRBDT) loans.

Before the transferable nil rate band provisions were introduced NRBDT in whole or part would often make loans to the surviving spouse which were left outstanding indefinitely and might be waived in whole or part after the individual’s death. If the loan is not repaid on the surviving spouse’s death, then on the face of it there will be no deduction for it for IHT purposes.  However, if the indexed increase in the loan is waived after death there will be a possible income tax charge on any indexed growth in the debt.  If the loan is repaid then there will be no income tax charge and at the moment the debt will be deducted for IHT; but in future if the trust is not ended on the surviving spouse’s death and the property is not or cannot be sold then there would not be the means to repay the loan and potentially no deduction will be made for the loan for IHT  It may be possible to argue that the repayment is for real commercial reasons and that the tax avoidance limb does not apply but this is far from clear at the moment.

 Practice Points

  • In future taxpayers will need to be careful where possible to show that investments into non-IHT assets were funded from spare cash and any loans taken out were for a different purpose.
  • The draft legislation may change but meanwhile review any cases where ‘non-commercial’ loans exist in trusts and estates and consider whether the s.175A IHTA 1984 amendment may hold a nasty surprise.
  • Consider whether any clients who are farmers, woodland owners or business owners may be caught by the new rules.
Gill Steel & Tracey Bowler

Gill Steel - Tel: 01962 776442
Email: gill.steel@lawskills.co.uk

Tracey Bowler - Research Fellow

Recommended Posts