One of the surprise announcements coming out of the Budget is a proposal to limit the amount of inheritance tax relief available for debts in certain circumstances. Currently, debts are normally deducted in full from the estate when calculating the value of the estate on which inheritance tax is payable. A debt that is charged on a particular asset (e.g. a mortgage) is deducted from the value of the asset on which it is charged.
The measure appears to be aimed at taxpayers in these situations:
(a) Those who take out loans specifically to invest in business or agricultural assets that qualify for inheritance tax relief; and
(b) Non-domiciliaries who are able to avoid inheritance tax by borrowing against UK assets and depositing the funds overseas.
Under the new rules, the debt will be set against the value of the asset that was acquired with the funds borrowed, thus cancelling the inheritance tax advantage that would otherwise arise.
The measure will also apply to certain other loans if they are not repaid after death. HMRC's announcement states that this aspect of the new measure is a response to certain avoidance schemes which involve contrived debts that are not subsequently repaid, so there is no real reduction in the value of the estate.
The new rules will have effect for inheritance tax arising on deaths on or after the date that Finance Bill 2013 receives Royal Assent. The date that the debt was incurred will not be relevant. Anyone who thinks they may be caught by the new rules will have to watch the progress of the Finance Bill to see if any amendments are made to these new rules and then consider taking professional advice if appropriate.
So far as existing arrangements are concerned, it may be obvious that loans have been taken out with a specific tax-driven purpose in mind. In future, taxpayers will need to be careful to show that, for example, investments into business property relief assets were funded from spare cash and any loans taken out were for a different purpose (in order to make gifts for example).
We anticipate that the new rules will not represent a complete block on the sort of inheritance tax planning arrangements that are targeted. For example, it may be possible for some loans to be re-packaged as sale and leaseback arrangements.